People struggling with debt might also be struggling to figure out their options for getting out of it. Looking through the options, debt consolidation and debt settlement is likely going to appear. But which should you choose?
Here’s the difference between debt consolidation and debt settlement.
What Is Debt Consolidation?
Consolidation is when various accounts are combined into one. There are a few ways this can be done and a variety of reasons and situations that can be improved through consolidation.
Let’s look at the major kinds of debt consolidation:
- Debt management plans: A credit counselor or debt relief agency can help set you up with a debt management plan. This is where you make one payment to an agency, which then distributes money to each of your lenders.
- Consolidation loans: This is a bit more specific, as a DMP doesn’t necessarily mean you’re taking out a loan — though it effectively functions as a consolidation. With a consolidation loan, you’ll open a new account with a new interest rate, and the balances of your qualifying unsecured accounts are moved over to the new one.
- Credit card balance transfers: Some people don’t realize credit card balance transfers are just another kind of consolidation loan. Wall you’re doing is moving your credit accounts to a single new one at a low introductory interest rate.
Overall, debt consolidation is a way for people who are just a little bit over their heads to get a more solid footing on their finances.
What Is Debt Settlement?
Debt settlement is a more intense kind of debt relief. The settlement is generally for people who are running out of options. With debt settlement, an agency tries to strike a deal with your lenders to accept a lower payoff amount in exchange for settling the debt in full with a single payment.
What’s Different Between Debt Consolidation and Debt Settlement?
So, what’s the difference between debt consolidation and debt settlement?
There are quite a few:
- Debt settlement is something you can technically do on your own without the help of an outside agency. However, attempting to do so is rarely met with success. Lenders often just see it as you trying to get out of paying them.
- Debt consolidation often involves taking out a new loan in order to get better terms than the net of a variety of unsecured accounts. Many people seek out debt consolidation loans for bad credit with firms like bills.com, as these can potentially get you a little bit of wiggle room to pay down your debt.
- Debt consolidation can actually improve your credit score if you do it the right way. You might take an initial hit from opening a new account and closing old ones, but this can be more than overcome by making timely payments.
- Debt Settlement is bad for your credit at first because you stop paying your bills in order to settle them. Since payment history is 35 percent of your FICO score, this is going to have a drastic impact on your credit. On the other hand, if you’re in need of debt relief, odds are your credit score has already been diminished.
- With both methods, you only make one monthly payment. But it’s for slightly different reasons. Consolidation means you now only have one account to pay down. Through the settlement, you’re sending money to a debt relief agency and avoiding your bills.
- Consolidation can lower your net interest rate, while the settlement is an attempt to get your debt forgiven.
There are situations where consolidation is clearly better than settlement. But there are also times when settlement is the better option. Talk to a credit counselor for advice on what route makes the most sense for you.