Being buried under a mountain of debt is an incredibly stressful situation. The constant calls from creditors, late fees piling up, and the fear of potential consequences like damaged credit scores or even bankruptcy can take a major toll.
If you’re struggling with unmanageable debt, you’re probably looking for a way out. Two popular debt relief options are consolidation and settlement. But which one is the better choice for your situation? Let’s explore the pros and cons of each approach.
What Is Debt Consolidation?
Debt consolidation loans roll all your existing debts into a single loan or credit card with a lower interest rate. Instead of juggling multiple debts with minimum monthly payments across different accounts where the likelihood of getting an 11 at t report is high because you can’t pay them on time, you’ll have just one consolidated payment to make.
The main benefits of consolidating debt are:
- Single monthly payment is easier to manage
- Lower loan interest rates can save you money
- Everything is streamlined and simplifies your financial life
How Debt Consolidation Works
Let’s say you have USD$10,000 in credit card debt spread across four cards at a 24% interest rate. You’re also paying USD$500 per month across these different accounts just to cover the interest charges, let alone touching the principal balances.
With a debt consolidation loan at 12% interest, you could pay off those high-interest credit cards. Now, you’d have one USD$10,000 personal loan at 12% interest with fixed payments, for example, USD$300 per month for three years. Not only is the monthly payment much lower but more of it goes toward the actual debt instead of just interest.
At the end of the loan term, your debt would be paid off completely instead of just perpetually treading water with minimum payments. And you’d save a ton in interest charges over the long run.
Debt Consolidation Drawbacks
While debt consolidation simplifies your financial life and could save you money, there are a few potential downsides to consider:
- Difficulty qualifying with bad credit
- Loan fees could reduce your potential interest savings
- Extends repayment timeline for remaining debt
- Removes a psychological reminder of previous debts once balances are consolidated
It’s also possible to fall back into old spending habits that create new debt on top of the consolidated loan. Good financial discipline is still required to make the strategy effective.
What Is Debt Settlement?
With debt settlement, you negotiate lump sum payments with creditors for less than what you originally owed. In essence, you’re asking lenders to agree to accept a lower amount and consider your debt paid off.
This might sound too good to be true at first. Why would lenders willingly accept a smaller payoff? Settling is often a last resort when the borrower is seriously delinquent on payments. Rather than go through an expensive collections process with no guarantee of full recovery, lenders sometimes opt for partial debt payments they can count on.
Debt Settlement Pros And Cons
The obvious advantage of debt settlement is being able to get out of overwhelming debts for far less money than you originally owed. If negotiated successfully, it could provide a fresh financial start.
The downside is that debt settlement severely damages your credit reports and scores in the short term. Having settled debts listed on your credit history looks very bad to future potential lenders. It can take years for your credit to fully recover.
There’s also a risk that your original creditors could decline your settlement offers. And any forgiven debt is treated as taxable income on your tax returns.
How The Debt Settlement Process Works
When pursuing debt settlement, you generally stop making any payments on your current delinquent accounts. Instead, you start funneling that money into a dedicated settlement fund managed by the debt settlement company you hire.
As your settlement fund grows over many months, the debt settlement company attempts to negotiate acceptable lump sum payoff amounts with each of your creditors. This requires your accounts to become even further delinquent, with late penalties and fees continuing to accrue.
Once you accumulate enough funds to satisfy a creditor’s settlement terms, the debt consolidation company pays the lump sum using your funds, and that debt is considered settled and paid off.
This process continues in cycles until all of your enrolled debts are settled in this manner. It can take two to four years from start to finish, depending on your specific debt load, settlement percentages, and how quickly you can accumulate funds.
While no payments are being made to creditors during this time, your credit scores take a massive hit from all the late payments building up. The settled status on those accounts also remains a negative item on your credit reports for up to seven years.
Which Option Is Better For You?
There are pros and cons to weigh with both debt consolidation and debt settlement. Your specific financial situation and goals will determine which option makes more sense (or if bankruptcy may be a better solution).
Consider debt consolidation if:
- You can qualify for low-interest rates (good credit)
- You want to pay off your debts in full
- You have a solid repayment plan and budget in place
- Preserving a good credit score is important
Debt settlement may be preferable if:
- You’re already severely delinquent
- Bankruptcy seems inevitable otherwise
- You can accumulate settlement funds patiently
- Rebuilding credit long-term isn’t a major concern
Be Wary of Debt Settlement Companies
Speaking of debt settlement, it’s important to be extremely cautious when hiring any third-party debt settlement company to handle negotiations and funds on your behalf.
While there are some reputable companies out there, the debt settlement industry is unfortunately rife with scams. Many of these firms charge outrageous upfront fees, lack transparency in their processes, fail to properly settle all debts, or even mishandle client funds entirely.
If considering debt settlement, it’s critical to thoroughly vet any company you intend to work with. Check for proper accreditations, read every bit of fine print about their fees and services, and dig into customer reviews and complaints as much as possible.
Consult With Experts First
No matter which debt relief path makes the most sense for your unique circumstances, it’s always wise to consult professional experts before making any decisions that could significantly impact your finances long-term.
Speak to certified credit counselors, bankruptcy attorneys, and financial advisors to get impartial third-party advice on your options and what approach might serve you best. These consultations are invaluable to avoid costly mistakes when you’re already in a fragile financial state.
The Bottom Line
Choosing between debt consolidation or debt settlement depends on factors like your current credit standing, income situation, time frame for debt elimination, and overall financial goals.
Consolidation provides a more straightforward path to repaying what you owe but requires sufficient income and modest interest rates to make it worthwhile. Settlement lets you walk away from debt for pennies on the dollar but absolutely decimates your credit in the short-to-medium term.
There’s no universally ‘better’ option – it all comes down to your particular needs. Do your homework, get professional advice, and pursue the responsible debt relief solution that helps rebuild your finances the right way.
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