Debt Settlement or Debt Consolidation?

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Men and women find debt consolidation and debt settlement both function to help consumers pay off their debt, but do so in very distinct ways. Debt settlement involves negotiating with creditors to pay the debt in full for less than the full amount owed. Individuals often use this method if they have an enormous debt with one creditor, although some people use this technique to resolve multiple debts with different creditors.

Debt consolidation, in contrast, merges debts from distinct creditors into one financial product. This product often features a lower interest rate and allows the debtor to make only one payment each month. Consumers must know the benefits and drawbacks of each option before determining which best meets their needs. You must know everything possible about reducing your debt before proceeding. 

Debt Settlement Advantages and Drawbacks

Debt settlement remains enticing to many men and women looking for debt relief, as it allows them to get this relief without paying the debt in full. This method comes with many drawbacks.

The debtor or someone working on their behalf speaks with creditors to see if they will allow the debtor to fulfill the debt for an amount less than what they owe. If a creditor accepts this offer, which they don’t have to, the debtor makes the payment and resolves the matter. Is it, though? To get debt relief, the debtor repeats this process with every creditor, a process which takes time and effort. As the process moves forward, the debtor continues to rack up late fees, penalties, and interest charges. This adds to the amount owed.

Debt settlement providers tell clients to discontinue payments to their creditors during the settlement process. This means the interest, penalties, and late fees continue to accumulate. If the creditor refuses to settle, the debtor pays the additional fees too. As the process typically takes anywhere for 24 to 36 months to complete, the debtor could be looking at significant fees and penalties to pay.

Prepare for the credit score to decline, as debt settlement negatively impacts it. Every missed payment and settled account means another negative mark on the credit report, and this information remains for seven years. As a result, anyone who makes use of debt settlement will find obtaining a new line of credit is difficult until the credit report and score improve.

The debt settlement company charges a fee for its services, typically a percentage of the total amount owed. Most companies charged 20 to 25 percent of the final settlement amount, and debtors need to factor this into the equation. Finally, be prepared to report any debt forgiven in the debt settlement process as income, which the IRS requires under its current rules.

Should This Option Be Used?

Debtors looking for a short-term solution often find debt settlement meets their needs. Gather the funds needed to make a lump-sum payment and then call the creditor to offer this amount. Nevertheless, this option shouldn’t be used by anyone who wants to secure a loan for any purpose in the near future. The negative impact on the credit report and score makes it difficult to find a lender willing to provide these funds.

Debt Consolidation Advantages and Drawbacks

Men and women who find themselves overwhelmed by the number of bills they must pay each month benefit from debt consolidation. However, this only works if the person understands they cannot take on new debt until they have paid the consolidation loan in full.

Most people find they are in debt because of their credit card usage. When they add in household bills, they discover it is easy to miss one or more payments in a single month, either because they overlooked a bill or they didn’t have the funds to pay it. When a person gets behind on a bill, it’s hard to catch up. Debt consolidation benefits those who are making minimum payments on their debt and never seem to get ahead.

Debt consolidation simplifies a person’s bill paying. They must make only one payment each month, and the interest rate tends to be lower. When a person makes a late payment or misses one completely, many card providers raise the interest rate on the card. A debt consolidation loan interest rate can be significantly lower. Paying the balances on multiple cards without closing them boosts a person’s credit score, as long as they don’t use the cards again.

With debt consolidation, creditors don’t forgive or reduce the debt. The debtor owes the same amount and will need to change their spending habits to avoid similar issues in the future. Additionally, the debtor needs a decent credit score to get a loan of this type. If the credit score is bad, the consolidation loan might come with an interest rate similar to that the debtor currently pays. Debt consolidation programs don’t erase debt overnight. The person can spend years paying off the consolidation loan, which some find to be a challenge.

Consolidating Debt

If a consumer decides debt consolidation is right for their needs, they must decide which method to use. Four types exist today, and each has benefits and drawbacks.

Debt management programs offer credit counseling and education programs to help consumers get their spending under control. The program typically takes three to five years to complete, and some people find this is too long for them.

Balance transfer credit cards benefit some debtors. They allow the debtor to transfer high-interest debt to a low-interest rate card. Nevertheless, card providers offer these cards to individuals with excellent credit, leaving many debtors to explore other solutions. Furthermore, companies frequently charge a transfer fee, and the introductory rate usually ends within 18 months.

Personal loans provide another option for individuals in debt. Interest rates on these loans vary, but many debtors find the rate to be less than what they currently pay. Nevertheless, borrowers pay an origination fee, some loan providers assess a penalty if the borrower pays the loan early, and certain lenders require collateral.

Home equity loans and lines of credit benefit homeowners who have money in their homes. Be careful if you choose this option. A failure to make payments as agreed puts the home at risk of foreclosure. Furthermore, borrowers must pay closing costs and, possibly, application fees.

Consider all debt consolidation options. One likely meets your needs. The relief you get when you consolidate, however, is priceless.

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