What is the difference between debt consolidation and debt settlement?
Debt consolidation and debt settlement are two personal debt improvement financial strategies, but they work very differently and are used to solve different problems. At a very basic level, debt settlement is helpful in reducing the total amount of debt owed, while debt consolidation is helpful in reducing the total number of creditors you owe. It is possible to receive secondary benefits through either strategy, especially debt consolidation.
Key points to remember
- Debt consolidation and settlement help you reduce your debt, but they do it in different ways and using different strategies.
- Debt settlement is helpful in reducing your total debts, while debt consolidation is helpful in reducing the total number of creditors you owe.
- With debt consolidation, multiple loans are all rolled into one new consolidation loan that has a monthly interest rate.
- With debt settlement, you or a credit counselor negotiate with your creditors so you can pay less than what you owe, often in a lump sum settlement.
What is debt consolidation?
Debt consolidation is a process in which you combine multiple debts into one consolidation loan. This is a single loan that consolidates all your past debts into one monthly payment at one interest rate. Consolidation loans are offered through financial institutions, including banks, credit unions, and online lenders, and all of your debt payments go to the new lender going forward.
Consolidating debt in this way can bring psychological benefits, as it relieves the stress of having to juggle multiple debt payments each month. It’s also possible that a consolidation loan will result in a lower total monthly payment or a lower average interest rate on your debt. The ability to save money on interest over time may depend on how long the loan is paid off and/or whether you pay any fees for the loan, such as an application or origination fee.
A debt consolidation loan can be secured or unsecured. Secured debt consolidation loans require you to use one or more assets as collateral, such as your home, car, retirement account, or insurance policy. For example, if you take out a home equity loan to consolidate your debt, your home will secure the loan.
Debt consolidation can help improve your credit score if you are able to reduce your rate of credit utilization, but it is important to monitor your credit reports and scores for any potentially negative impact.
What is Debt Settlement?
While debt consolidation allows you to combine multiple debts into one loan, debt settlement uses a very different strategy. When you settle a debt, you are effectively asking one or more of your creditors to accept less than what is owed on your account. If you and your creditor(s) reach an agreement, you will pay the settlement amount in a lump sum or in a series of installments.
The advantage of debt settlement is that you can eliminate debts without having to pay the balance in full. This can be an attractive alternative to bankruptcy if you are considering a Chapter 7 filing as a last resort when you are in dire financial straits.
It is important to remember, however, that creditors are not required to enter into negotiations or accept your offer. Additionally, you will need to keep in mind that offering a settlement requires you to have cash to pay the agreed amounts. If you don’t have the cash to negotiate, then seeking a debt consolidation loan may be the best option.
Generally, creditors will only consider debt settlement for overdue accounts. Therefore, if you are always up to date on your balances, this may not be an option.
|Debt Consolidation vs Debt Settlement: Key Differences|
|Debt Consolidation||Debt settlement|
|How it works||The debts are consolidated into a single loan with a single interest rate.||Debt balances are negotiated to pay less than is owed.|
|Impact on credit score||Can help improve credit scores if it lowers your credit utilization rate.||The history of late and delinquent payments for a settled account could affect your credit score.|
|Cost||Debt consolidation loan interest rates vary; some lenders may also charge a fee.||Debt settlement may not cost anything if you do it yourself, but debt settlement companies may charge a fee for their services.|
|Advantages||Consolidating debts into one payment could make repayment easier and you could save money on interest.||You can eliminate debts for less than is owed and avoid collection actions, including lawsuits from creditors.|
|The inconvenients||Depending on the term of the loan, you may pay more interest over time.||Not all creditors can agree to a debt settlement, and late payments can hurt your credit rating.|
How to Negotiate a Debt Settlement
Debt settlement requires you to have negotiation skills, but the process itself is not that complicated. If you are behind on one or more debts, you will start by contacting your creditor to ask if they are ready to negotiate a settlement. You can do this over the phone, but if you prefer to have a written record, you can send a written request.
At this point, the creditor can do one of three things: accept your settlement offer, reject it, or make a counteroffer. If your creditor chooses to make a counter-offer, you can assess whether the amount they are asking for is realistic for your budget.
Once you and a creditor agree on a settlement amount, you can make arrangements to make payment. Again, you may be asked to make a single lump sum payment or multiple installments, depending on the creditor. Your method of payment may vary and includes sending an electronic payment from your bank account, wire transfer or paper check.
Once a debt is settled, it disappears – the remaining balance is cleared. However, with unsecured debt such as credit cards, you risk having your account closed completely after settlement because the lender won’t want to continue extending credit to you. This, and any late payment history associated with the account, could cost you credit points.
If you are not comfortable with negotiating debt settlement on your own, you can hire a debt settlement company to do it on your behalf. Be aware that this will likely involve paying a fee. You can contact the Federal Trade Commission or the National Consumer Law Center for free information on debt negotiation and debt negotiators.
Be sure to create a written record of all communications and payments regarding debt settlements, in case a creditor tries to come back later and claim payment for any canceled balances.
Debt Consolidation or Debt Settlement: Which is Better?
If you’re considering the best way to manage your debts, you may be weighing debt consolidation versus debt settlement. But one may be a better choice than the other, depending on the specifics of your financial situation.
For example, if you just need a way to make your monthly payments more manageable for your budget, then consolidating debt into one loan might make sense. Keep in mind that you will need good credit to qualify for the lowest rates on personal loans for debt consolidation.
If you are already behind on one or more debts and your creditors are threatening to sue you, you might consider settling your debts instead. Assuming you have cash to make settlement payments, this might be less financially damaging than filing for bankruptcy protection.
If you’re looking for debt consolidation loans, take the time to compare the annual percentage rate (APR), fees, loan repayment terms and minimum credit score requirements to find the best loan options. .