Debt Consolidation or Debt Settlement – Understand the Differences to Make the Right Choice

An analysis of the latest figures put out by the Federal Reserve, published in, reveals that consumer debt accounts for as much as 26% of the annual income of the average American. These statistics underline what is perhaps very well known; Americans are forever struggling to pay off debt but most have simply no idea how to do it effectively. The confusion is further compounded by the high-decibel advertising of debt consolidation and debt settlement by private finance companies as ultimate solutions to getting rid of debt. Since the confusion can result in your making an uninformed decision, you may actually end up making your financial situation worse. A quick glance over the merits and disadvantages of debt consolidation and debt settlement:

How Does Debt Consolidation Work?
Debt consolidation is a very popular method of getting on top of debt, especially for people who have racked up multiple debts and find it difficult to monitor them. As a result, the minimum monthly payments get missed and additional penalties and even penal rates of interest are slapped on making the debt situation worse. Debt consolidation is just another name for finding out the total of all the individual debts and taking on a new loan with which, to pay them. You end up with only one loan to track and one monthly payment to make.
Different Ways of Consolidating Debt
While debt consolidation loans are popular simply because of the advertising by the private lenders, there are quite a few other ways of consolidating unsecured debt. One of the best ways of saving on the interest expense is to try and obtain a zero-percent balance transfer offer from a new or existing card. All the existing credit card dues are then swept into the new card and you have to make only the minimum monthly payment with no application of interest during the promotional period that could be as long as 18 months. If you have a mortgage, you can refinance it or even get a home equity line of credit at a very low rate of interest. However, you need to be cautious because defaulting on the repayment could put your home at risk. Similarly, a 401(k) loan can be a cheap source of funds for repaying your credit card but you could end up compromising your financial security after retirement if you can’t pay the loan back on time.
Potential Benefits of Debt Consolidation
You have to keep in mind that by consolidating debt, you do not reduce your debt amount. Potentially, the benefit is that you can reduce your interest expense if you have a good credit score and also restructure the loan tenor to make the monthly payment more affordable. By consolidating the debts, you no longer have to bother about monitoring multiple creditors and adhering to different pay-by dates. A temporary dip in the credit score will be experienced when you take the balance transfer offer or the new loan, however, as you start paying off the new loan regularly, your score will improve. Also, the existing credit cards dues having become zero, the increase in credit availability ratio will also send out positive signals to the credit bureau.
What Is Debt Settlement?
When you have so much debt that there is no hope of being able to pay it back given your financial circumstances, filing for bankruptcy is a very real possibility to get your life back on track. However, since bankruptcy is a very drastic step and has a long-term impact on your financial future, it is better to consider settling your debts. Debt settlement is a proposal that you make to your unsecured creditors like credit card companies to make a lump sum payment in full and final settlement of your dues.
How Does Debt Settlement Work?
According to most of the debt settlement feedback online, the success of debt settlement depends on the ability to prove that your financial distress is genuine and that settling the debt is the only way to prevent bankruptcy. You will be advised by the debt settlement company not to make any further payments to the card company and instead, deposit an amount determined by them into a bank account set up, especially for this purpose. Once the money in that account is determined to be sufficient, the debt settlement company negotiates with the creditor to accept a lump sum payment that is substantially less than the amount owed. Since the account is already overdue and there is enough evidence that the customer does not have the means to pay the full amount, the card company may agree to settle since it represents the only hope of getting some of the money back.
The Pros and Cons of Debt Settlement
The advantage with debt settlement is that you get to reduce your debt substantially and save yourself from bankruptcy. However, debt settlement has an adverse impact on your credit score that stays on your credit report for as long as seven years. During the time, you are not making payments to the creditor; the due amount will zoom due to the application of penalties and interest. Your credit will keep on taking a hit during this time with every payment you miss. In addition, the fees payable to the debt management company will need to be factored in. You will still be chased by debt collectors and may even be sued before a settlement has been arrived at. You will also be liable to pay income tax on the forgiven amount in excess of $600 unless you are a proven insolvent.
Given the downsides of debt settlement, it is very apparent that is should be attempted only if you do not have an alternative to save yourself from bankruptcy. If you are in a debt trap, it is very important that you change your lifestyle to cut down on your expenses, try to increase your income and cash surplus, and consolidate debts to save on the interest payment. If at all there is no alternative to debt settlement, it is vital that you find a company that is professional, transparent, ethical, and efficient to help you to settle for as less as possible.


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