When you are struggling with debt repayment, people may often suggest that you consider debt settlement or debt consolidation. While both are forms of debt relief, they are often used interchangeably leading to a lack of clarity. It needs to be appreciated that the two are actually quite different from each other and have their own benefits and disadvantages. Debt settlement involves negotiating with creditors to make them accept an amount that is less than the dues in full and final settlement of the debt. Debt consolidation, on the other hand, does not involve any reduction of the debt amount. It is a method by which debts from multiple creditors are combined and a single loan is taken out to settle all of them. While both methods are intended to make debt more manageable, the pros and cons of each are different with regard to the time to get rid of the debt, the impact on the credit score, and the savings.
Debt Settlement – How Does It Work?
Debt settlement has always been projected to be very enticing as it is possible to slash debt by as much as 50% or even more, however, since there are quite a few severe downsides associated with it, experts on debt management suggest the method to be used only after everything else has failed. However, the American Fair Credit Council (https://americanfaircreditcouncil.org/wp-content/uploads/Regan-Report-Short-Version-FINAL-AFCC-Brand.pdf) asserts that “95% of debt settlement clients receive savings in excess of fees.”
It is because credit card debt is unsecured that the card companies often agree to settle the debt if they think that the cardholder is so financially distressed that it is quite likely he would file for bankruptcy and they would get nothing. If the card company is convinced that it is in their best interest to settle the debt, they will make an offer. The process of negotiation can be quite protracted and has to be repeated for each of the cards that you have maxed out.
The Negatives of Debt Settlement
Debt settlement should be a carefully considered decision because even though the debt can be slashed a lot, there are several disadvantages. The debt settlement company will generally advise you to stop making any further payments to the credit card accounts and instead deposit the available money into a specially designated account. In the period you are not paying the card companies, the debt outstanding keeps on growing because of the interest and the penalties. The time taken for settlement is typically two to three years, so the interest and penalties added on can be quite substantial. During this period, your credit score also keeps taking a hit and the settlement remains on your credit report for as long as seven years. You will also have to deal with the fees charged by the debt settlement company that is generally 20-25% of the amount of debt reduction. Additionally, the IRS requires you to pay tax on the amount forgiven. However, the biggest concern with debt settlement is that the lender is not obligated to settle and you cannot plan of getting a substantial reduction. You may find yourself with a larger amount of debt, a delinquent card account, a bottomed-out credit score and a court case against you to boot all for nothing. Debt settlement should actually be treated as the last resort before filing for bankruptcy. The debt settlement ratings of the top companies can be used as a basis to make a shortlist of the companies you can inquire with.
Debt Consolidation and Its Benefits
If managing multiple credit cards is proving difficult and you are missing out on the monthly payments because either you are short of cash or forgetting to pay on time, debt consolidation may well be the answer. The process involves getting a new loan for the aggregate amount of all your existing card balances and repaying them. Even though there is no reduction in the amount of the debt, it has some very obvious benefits. With debt consolidation, you no longer have to bother about tracking multiple card statements and remembering to pay on time. You now have only one debt to service. Provided you have a good credit score, you will find that the interest rate applicable on a debt consolidation loan is far lower than the typical credit card APR so you will save a lot on the interest expense. Further, you can negotiate with the lender for a longer repayment period to make the monthly payment more affordable.
Methods of Debt Consolidation
One of the most popular ways of debt consolidation is making use of zero per cent APR balance transfer offers by credit card companies. You can use this facility if you are eligible for such an offer to sweep all the card dues into the new card and use the interest-free period of 15-18 months to repay the outstanding amount. The method is effective only if all your debt is credit card dues and your credit score is good enough to get you a balance transfer offer from a new or an existing card. You will generally need to pay a transfer fee of around 2% of the amount transferred.
Another common way of consolidating debt is to get a loan from a debt consolidation company, which is a lender specializing in lending for this need. The rate of interest that you will be charged will depend on your credit score. If you have a good credit score, the difference between the interest rate and the credit card APR can translate to a substantial saving. However, you need to watch out for the fees payable that can often take a chunk out of the potential savings. A home equity line of credit can also be used profitably as the rate of interest is really low, however, you could be putting your home at risk if you default on the repayment.
You will need to take stock of your financial situation very critically so that you can make the right choice between debt consolidation and debt settlement. Normally, experts suggest debt settlement be undertaken as a last resort before filing for bankruptcy.