January 6th, 2010
Debt Consolidation vs Debt Settlement: The Right Debt Relief Plan For You
If debt relief is one of your financial goals for 2010, debt consolidation and debt settlement are two important options to consider if you can no longer manage debt on your own. Understanding the differences between both options will help you determine what is appropriate for your debt situation. Most consumers have some kind of debt but not all choose to consolidate or settle their debt; it isn’t a magic ticket out of debt and there are downsides to both. But, if they fit your financial needs, debt relief plans can help to make your debt load lighter and easier to manage.
Why debt consolidation might be right for you
Debt consolidation uses a third-party agency to combine your multiple debts, like credit card bills or student loans, and convert them into a single, large loan. The most advantageous side to having only one loan is the convenience and affordability of handling one repayment plan rather than multiple bills. Think of it as a refinance for your debt—you can negotiate a lower interest rate to lower your monthly payment. However, you will be paying a longer term on a debt consolidation loan so the lower interest rate can add up.
As with any financial decision, calculate how much you’ll cut down in monthly payments with debt consolidation and whether it is worth the longer term and additional interest. Once the debt consolidation process gets underway, don’t forget to continue to make payments on your accounts until the loan takes over or your credit score will take a hit. Maintain on-time payments on your new loan and the positive payment history and reduced debt can improve your credit score.
If this sounds like the right debt relief path for you, review several agencies’ qualification requirements, which can include a minimum credit score, minimum monthly income, steady employment, and sometimes home ownership (debt consolidation often comes in the form of a home equity loan).
Why debt settlement might be right for you
In debt settlement, a third party firm negotiates directly with creditors on your behalf to reduce the total amount of debt owed, sometimes as much as 50-70%. Debt settlement deals with one debt (whereas debt consolidation has multiple debts), and once the creditor agrees on an amount, you must pay that amount within a few days. The most crucial factor in this plan is ensuring you have the funds prepared to pay the entire debt settlement amount immediately.
While a lower credit card debt sounds good, it comes at the cost of your credit score. When you agree to settle a debt, it damages your credit score anywhere from 45 to 125 points depending on your credit standing. Your debt will be wiped immediately, but your credit score will suffer in the long run.
Also, this process isn’t for everyone and several factors affect whether or not a creditor will agree to settle your debt. Debt settlement firms typically only work with those with evident financial hardship, such as people owing more than $7,500 in debt; creditors will not want to settle a debt with someone who could afford to pay the original debt in full. Creditors will also take a look at your account history to assess whether you knowingly ran up a huge balance you couldn’t repay.
The right fit
As you decide what’s right for you, consider which long-term and short-term consequences you are ultimately prepared to deal with? Debt consolidation simplifies repayment with minimum effect on your credit, but you’ll face a longer loan term and ultimately pay more in interest over the life of your loan for the trade-off of having smaller monthly payments now. With debt settlement, you can reduce and pay off your total debt right away, but at the cost of damaging your credit score for the next few years. Once you choose your plan of action, seek out professional debt consolidation agencies or debt settlement firms and compare their offers. Now breathe easier—you are on the way to shedding debt and improving your financial health.
At Credit Karma Blog, what goes around comes around… So what do you think about this post? Agree, disagree, or have something more to say? We’d love to hear your reactions!
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To identify the difference between debt consolidation and debt settlement will be a touch one as there is no perfect solution for getting out of debt. Debt settlement
can help you see an instant improvement in your finances, but at the
cost of your credit score. Debt consolidation simplifies the process with
minimum affect on your credit, however it does take time.
If debt relief is one of your financial goals for 2010, debt consolidation and debt settlement are two important options to consider if you can no longer manage debt on your own.