Any unsecured debt, especially a credit card debt can become quite costly for you with time. With an average interest rate of 20% and complicated payment structures, it really becomes difficult for people to pay off the amount easily. Even if you want to pay it off, it will cost you thousands of dollars with a monthly plan lasting for decades. Things can get more overwhelming if your financial situation isn’t up to the mark and you are facing a crisis where you can’t even afford the monthly installments.
Fortunately, there are multiple debt relief options for such situations where you can cut down on your interest and even reduce the debt. Debt consolidation and debt settlement are two of the most famous options that people often use when stuck with a huge loan. However, you first need to know which option suits you the best in debt settlement vs debt consolidation. Let’s break it down for you!
Understanding Debt Settlement
In a debt settlement, you have to negotiate for a lower settlement with your creditor. You can do the negotiation yourself or hire a professional service to bring both the parties on benefiting terms. In such an agreement, you request the creditor to write off half or more of your debt and you on the other hand have to pay the rest of the amount as a lump sum or in installments.
Debt settlement is the better alternative especially if you are on the edge of considering bankruptcy. Bankruptcy should be one of your last resorts because it can cause unimaginable damage. On the other hand, debt settlement comes with an advantage of reducing your debt so you don’t have to pay the balance in full. However, it will hurt your credit score.
No creditor is under any obligation to accept your settlement offer and if you want to give it a try, you first need to have cash ready as per the agreed upon amount.
Understanding Debt Consolidation
Debt consolidation is another one of the most popular debt relief options. This option suits those the best who have multiple debts to deal with every month. Multiple debts means multiple interests which increases the overall cost of your loan. This is where debt consolidation loan can work wonders for you! Consolidating your debt means rolling all of your other debts into one.
You take up a consolidation loan, pay off all your other creditors with that amount and then just focus on the consolidation loan and its monthly payments. There are several banks, credit unions and private lenders out there providing both secured and unsecured consolidation loans.
A consolidation loan will help you lower your total monthly payment with a lower average interest rate. For a secured consolidation loan, you need to use one or more of your assets as collateral. For example, if you take a home equity loan, your house will be used as the collateral if you aren’t able to pay the loan off as per the payment plan.
Pros And Cons Of Debt Settlement
In order to make a more informed decision, here are some pros and cons of debt settlement that you must consider;
| Pros Of Debt Settlement | Cons Of Debt Settlement |
| Save Money: You can save yourself thousands of dollars, depending upon your situation and the total amount you owe. | It Will Hurt Your Credit Score: One of the biggest downsides of debt settlement is that it will hurt your credit score and it can stay on your credit report for up to 7 years. The damage is temporary but if you don’t rebuild your credit, it can cause some serious unwanted consequences in the future. |
| Avoid Bankruptcy: Debt settlement is the best and the only solution to avoid bankruptcy. Filing bankruptcy means wreaking havoc to your credit report as it will stay there just like a lifelong companion. | Debt Settlement Fees: Hiring a debt settlement service means you’ll have to pay a fee, ranging from $500 to $5000. The fee won’t reduce your debt, in fact, it will go straight to the agency providing you the service. |
| You Won’t Have To Deal With Collections: Entering into a debt settlement agreement means you won’t have to deal with the collection agencies. When your debt is sold off to a collection agency, it can become a real struggle for you to deal with them and the whole process can just drain you. | Creditors Can Reject The Negotiation: A debt settlement comes with no guarantee as the creditor is under no obligation to accept your offer. A creditor can reject your offer straight away. Even if you hire a third party for the negotiation, there’s no guarantee that your deal will go through. |
Pros And Cons Of Debt Consolidation
Even if you opt for debt consolidation, there are some downsides to it. Here’s what can go wrong and what can go well in debt consolidation;
| Pros Of Debt Consolidation | Cons Of Debt Consolidation |
| Simplifies Finances: When you consolidate your debt, you won’t have to worry about multiple monthly installments and you can easily focus on just one payment with a relatively lower interest rate. | Missing Payments Will Set You Back Further: If you delay your repayments, you’ll have to pay the penalty for it and it will also hurt your credit score. In simpler words, a single missed payment can increase your debt amount and set you back. |
| Lower Interest Rates: Multiple debts means multiple interests and this can just make your loan very costly. In debt consolidation, if you have a good or an average credit score, you can easily qualify for a lower interest rate. | You May Pay A Higher Rate: With a low or poor credit score, you might have to pay more with a consolidation loan. Lenders will see you as a risk and eventually you’ll have to pay more for credit and you’ll be able to borrow less. |
| It’s The Faster Route: If you want to become debt-free quickly then debt consolidation is the ultimate solution. With monthly repayments and a lower interest, you can easily pay off your entire loan amount. | Upfront Costs: Sometimes, debt consolidation loans come with additional fees including, annual fees, closing costs, loan origination fees and balance transfer fees. You are supposed to check such details before choosing a consolidation loan provider. |
Which One Is Right For You?
When it comes to debt settlement vs debt consolidation, it’s not that difficult to tell which option is right for you. Moreover, there’s no one answer that fits all and the right option completely depends on your financial situation and the amount of money you owe to your creditor.
When Debt Consolidation Is Better: If you have a manageable amount of debt and can afford to make the monthly repayments then consolidation is better than a settlement. Moreover, debt consolidation makes a great choice for someone dealing with a high interest because that’s what happens here, consolidating your loan means you’ll be able to get a lower interest rate only if you have an average or above-average credit score. In simpler words, if your only priority is to save on interest charges and simplify your monthly installments to pay off your debt faster than debt consolidation is definitely for you.
When Debt Settlement Is Better: If you are much further down the road and are only left with the option of bankruptcy then debt settlement is the right way forward. This scenario is best for those who can’t even afford a consolidation loan, are way behind their monthly payments and are facing a financial hardship that’s making it really difficult to pay off the debt. Moreover, debt settlement is for everyone including those with a poor credit score. For a consolidation loan, you need a good credit score but if you don’t have one and really want to reduce your debt then a settlement will be worth it.
How Each Affects Your Credit Score?
Now that you know the difference between debt settlement and consolidation, it’s time to learn about its impact on your credit score.
No matter which debt relief option you choose, remember that it will have a negative impact on your credit report. However, the impact is always temporary and you can rebuild your score with the right measures, i.e, showing a financially responsible behavior.
Impact Of Debt Consolidation On Credit Score
Debt consolidation can hurt your credit score in the short term but in the longer run, it’s the best option if you want to improve your credit score or just build one from scratch. When you apply for a consolidation loan, it will add a hard inquiry to your credit file. Moreover, when you close your old credit card accounts after consolidation, it will reduce your credit and your credit utilization ratio too, which will ultimately give a dip to your score. All of this negative impact is just temporary and when you start making your repayments on time without any delays then you’ll see your score recovering from all the damage.
Impact Of Debt Settlement On Credit Score
Debt settlement will negatively impact your credit score because you’ll be paying less than what you owe to the creditor. Such negotiations negate the original credit agreement which is why you’ll experience a dip in the initial stage. Especially during the process of debt settlement, your score might be reduced by 100 points. However, it’s still a better option to start a debt settlement negotiation instead of just completely ignoring the debt. You can easily recover from the damage by just making timely payments, avoiding any further debts and keeping your credit utilization ratio low.
Costs And Fees Comparison
| Debt Consolidation | Debt Settlement | |
| Costs | Balance transfer fee, interest and origination fee | Debt settlement company fees |
| Process | Consolidating high interest debts into a single low interest debt | Negotiating with your creditor to reduce your loan amount and pay them a lump sum amount to settle your debt. |
| Credit Score Requirement | You need a good or at least an average credit score to consolidate your debt | No credit score requirement at all. Even with a below average score, you can enter a settlement. |
| Financial Impact | You can pay down your debt faster and it will also reduce your debt amount along with your interest, saving you a lot of money in the long run. | Your creditor will forgive a decided percentage of your debt. The forgiven debt may come with a tax bill that you’ll have to pay. |
| Credit Score Impact | Will initially damage your credit score but you can improve it with time. | Can cause long lasting and heavy damage to your credit score which will take years to recover. |
Real Life Cast Studies
Case Study: Debt Settlement For Credit Card Debt
Name: Ava, a 30 years old professional.
Background: Ava had an accumulated credit card debt worth $25000 after going through a medical emergency that led to job loss too. She couldn’t afford to make the monthly repayments and was constantly being harassed by debt collectors. Due to her overwhelming situation, she took help from a debt settlement company.
Debt Settlement Process:
- After going through her finances, the company then proposed to negotiate with her creditors to reduce the amount of loan.
- Within 12 months, they were able to convince the creditor for a 40% settlement which reduced her debt from $25000 to $10000.
- Ava used her savings and took a personal loan from her relatives to pay the lump sum amount as per the decided agreement.
Outcome:
- Ava didn’t have to declare bankruptcy and she was able to reduce her debt successfully.
- During the settlement process, Ava’s credit score took a dip significantly but after paying the $10000, she was able to improve her score with time.
- Even though Ava faced some unwanted circumstances, especially with her credit report. After the settlement, she was relieved and was able to gain complete financial control.
Case Study: Debt Consolidation For Credit Card Debt
Name: Joshua, a 40 year old professional
Background: Over several years, Joshua had an accumulated credit card debt of $30,000. Almost all his cards came with high interest rates which is why it was becoming difficult for him to pay them off. Due to delay in his payments, his credit score was dropping which was draining Joshua as he had to make multiple payments to multiple creditors every month.
Debt Consolidation Process:
- Joshua decided to consolidate his debts and rolled them into one personal loan.
- His bank offered him a personal loan with an interest rate of 7% which was way less than what he used to pay altogether to his creditors.
- Joshua took a loan of $30,000 to pay off all his creditors. He closed all his accounts and then focused on a single consolidated account that came with a minimum monthly payment with a lower interest rate.
Outcome:
- Joshua had a fixed loan term to deal with and his monthly payments reduced by 30% which saved him a lot of money.
- His credit score started showing improvement after he paid off all of his other creditors.
- Within just four years, Joshua was able to pay off his personal loan too, in full. After clearing his debt, Joshua was able to make more informed financial decisions in the future and he also avoided any more credit card debts.
The Bottom Line
If you want to eliminate debt and get rid of all the fuss then debt consolidation and debt settlement, both are some of the most effective options. The better option just depends on your financial situation and of course the amount of your debt. If you are able to afford making minimum payments every month but don’t see yourself getting out of debt anytime soon then consolidation is definitely the answer. On the other hand, if you can’t even afford to make the minimum monthly payments due to some financial hardship and would rather reduce the amount of your debt then debt settlement is the ultimate solution for you.
FAQs
Q1. Will Debt Consolidation Hurt My Credit Score?
Yes, with debt consolidation you’ll experience a temporary dip in your credit score but in the long run, it’s a great option if you want to build a good credit report. Your score will eventually increase once you clear all your previous debt accounts.
Q2. What Are The Four “C’s of Debt Consolidation?
The four C’s of debt consolidation are, Character, Capacity, Capital, Conditions. There’s a fifth and sixth addition to these C’s now, Collateral and Competition.
Q3. Is Debt Relief Guaranteed?
No, there’s no guarantee when it comes to debt forgiveness. Moreover, the process of debt relief can have a temporary but significant negative impact on your credit score. It will also affect your ability to borrow in the future.
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