While these two approaches to debt relief do have some commonalities, they are quite different. Moreover, your ability to implement one or the other varies according to your financial situation and your credit history. Let’s take a look at debt settlement vs. a debt consolidation loan to determine which is best for your particular situation.
What Is Debt Consolidation?
There are a number of different ways to accomplish debt consolidation. You can transfer existing credit card balances to a new card with a limit high enough to encompass them all, you can take out a personal loan, you can tap into the equity you may have in your home or another real estate holding or you can enter a debt management plan.
In so doing, you’ll effectively roll all of your outstanding loans into one. The advantages of doing so include a potentially lower monthly payment, fewer obligations to track and lower interest payments — if you can consolidate a collection of high interest loans into one with a lower interest rate.
What Is Debt Settlement?
Like consolidation, you’ll group all of your unsecured obligations into a single package, which takes the form of a special account into which you make monthly deposits. Debt settlement professionals will negotiate with each of your creditors in turn to try to secure forgiveness of interest, fees and a portion of the principal amount owed.
This form of debt relief can reduce the amount of your obligation, which will make repayment easier. In exchange for these concessions, your advocate will offer your creditors timely payments of the agreed upon settlement amounts. To accomplish this, you will keep depositing money into that account from which those payments will be disbursed — usually rather than paying your creditors directly yourself.
Debt Consolidation Considerations
All forms of debt consolidation, save management programs, require you to have a pretty strong credit score. After all, you’ll need to qualify for a new loan to wrap around your existing debt.
Moreover, in the case of an equity loan, you’ll be trading unsecured debt for debt secured by an interest in real property. You’ll be putting your home at risk if things go sideways and you can’t repay the loan when that real property is your principal residence.
You must also be careful to determine the causation of your situation and eliminate it. Otherwise, you’ll be digging a deeper hole for yourself. You’ll have a stack of credit cards with zero balances after you consolidate all of those obligations into one loan.
You can see this coming — right?
You’ll wind up with a bunch of new balances to go along with the payment you’re making on the consolidation loan if you start charging again. This is why most management programs require you to close credit accounts while you’re participating in them.
Debt Settlement Considerations
Settlement often means you aren’t paying your creditors at all while you’re building up your settlement fund. This means more late and missed payments will be logged on your credit history — with an accompanying drop in your credit score. On the other hand, that’s probably already happened if you’re a viable candidate for settlement.
Settlement is not a guaranteed solution, as some creditors may refuse to go along. Also, settlement only works on certain types of unsecured debt. Mortgages and car loans are immune, as the assets they support can be repossessed. Government-backed student loans are immune to settlement as well. Moreover, the amounts creditors agree to forgive may be reported to the IRS as “income,” on which you could have to pay taxes.
When it comes to deciding which is best between debt settlement and debt consolidation, the real differentiators are the strength of your credit score and your ability to pay. Consolidation is the best way to go if your score is still good and you can handle the monthly payment it will bring. Otherwise, debt settlement is the more viable choice between these two.