Difference Between Debt Settlement and Debt Consolidation

When Debt Becomes a Problem

When a debtor faces overwhelming debt that cannot be paid, he must consider several options. Ignoring the problem will not make it go away, although many people attempt to do this, hoping that the statute of limitations will run out on the debt at some point. The problem is, if the individual has employment of any type that is reported to the IRS, the creditors can find him/her.

Other options include one of the two types of bankruptcy, debt settlement or debt consolidation. Responsible debtors who want to get relief in a legal manner, but who do not want a bankruptcy on their credit reports, will consider the remaining options. The difference between debt settlement and debt consolidation are quite specific and, before making a decision, the consumer needs to understand what each entails.

What is the Difference?

Debt consolidation is the process of obtaining one large loan to pay off all creditors who are holding “bad” debt. Bad debt is defined as that for which there is no collateral (e.g., home, car, etc.) and which has been accumulated in the purchase of goods and services which are not permanent. The debtor secures a loan which usually has a lower interest rate and/or which provides for lower monthly payments than the combined total of the former debt.

The relief provided is that the debtor has a monthly payment which he can afford, and, can more easily provide for monthly living expenses. If a debtor’s credit is still good, he can often obtain such a consolidation loan himself, from a credit union, a bank, or through accessing the equity in his home through an equity loan or line of credit, or through a complete refinance of the home, taking cash out to pay off the debt.

The advantage of using home equity is that the interest rates on these types of loans are usually lower than other conventional loans. If the credit rating is already affected by late or missed payments, however, securing a debt consolidation loan may be almost impossible without contracting the services of a consolidation professional. This individual may be able to negotiate lower overall debt amounts and secure a loan for the debtor. There are fees involved for these services, which are usually added to the loan amount.

The one benefit of a debt consolidation loan is this: if the original debt amounts are paid in full, the credit rating actually jumps up a great deal, enabling the consumer to get future credit at very reasonable rates.

Debt settlement is a process of negotiation to lower the amount of each debt a consumer owes. If an individual is strong, assertive and committed, he can complete this process himself, once he is 60-90 days behind in payments on credit card and revolving debt. The creditor, facing the possibility of getting nothing at all, is usually willing to negotiate a lower debt amount for the prospect of getting something.

If an individual is not knowledgeable in the process of settlement or does not have the assertiveness to negotiate from a point of strength, it is preferable to employ the services of a professional debt settlement individual or agency. The major purpose of this process is to lower the total debt amount, not to consolidate existing debt into one larger loan.

Unlike debt consolidation in which debts may be paid in full, the settlement agreement is usually reported to the credit bureaus as a “settlement for less than the original amount.” This damages a credit rating, and the individual must work steadfastly and consistently to repair the damage to the credit score.