Viewed from an altitude of 10,000 feet, debt consolidation and settlement look remarkably similar. After all, you’re basically rolling all of your debt into one basket so you can make a single payment each month to satisfy your obligations. However, there are some significant differences between the two approaches — with entirely different consequences.
Thus, it’s very useful to ask should you consolidate or settle your debts?
Let’s take a look.
What Is Debt Consolidation?
The simplest way to describe debt consolidation is you’ll take out a loan of an amount sufficient to pay off all of your outstanding debts (or as many of them as possible). This can take the form of a home equity line of credit, a refinancing loan on property you own, a personal loan or a credit card balance transfer.
The key advantages to this strategy are a reduction in the number of creditors with which you must deal each month, lower interest rates and a lower total monthly payment. These can be of substantial relief to someone struggling to keep up with their monthly credit agreements.
In all frankness though, this always works best for someone whose credit score is still strong. After all, the higher your credit score, the lower the interest rates you’ll be asked to pay. This can result in significant savings over the lifetime of the consolidation loan.
What Is Debt Settlement?
The most expedient method of characterizing settlement is this: You’ll contract a debt specialist to negotiate with creditors on your behalf to try to secure forgiveness of part of your obligations. In exchange for granting such concessions, your creditors will want to see the account paid in full, according to the agreed-upon terms, in a timely manner.
To make this happen, you’ll need to open an account with the settlement firm into which you’ll deposit a certain amount monthly. When the account has accrued a balance capable of paying off one of your creditors, negotiators reach out and attempt to reach a settlement. If it’s successful, your accrued funds go toward paying it off. This process repeats for each account you enroll in the settlement program.
So, like consolidation, you’ll make a single payment each month, but the consequences of each approach are quite different.
How Consolidation and Settlement Differ
Consolidation is generally undertaken while your credit history is largely unblemished and it remains so once you’ve satisfied the loan. The accounts are maintained in good standing and your creditors are paid in full. This typically results in a higher credit score — assuming you handle the consolidation loan according to the dictates of its agreement.
With settlement, you may decide to stop making payments to your creditors while your account amasses enough funds to kick-start negotiations. This means you’ll appear to miss a lot of payments and your creditors will make their consternation about it known to the big three credit bureaus (Experian, Equifax and TransUnion). These, in turn, can log negative information on your credit reports. So, this strategy is more so an option for people who have already seen their credit damaged by missed or partial payments — completing settlement can give you the opportunity to start rebuilding your financial health.
Long story short, consolidation can save your credit score, while settlement will most assuredly diminish it. There are certain situations in which you can avail yourself of a hybrid of the two approaches, such as the invitation-only consolidation programs offered by Consolidation Plus. These can serve to soften the hit settlement imposes.
So, Should You Consolidate or Settle Your Debts?
If your credit score is strong, but you’re struggling a bit to keep up, a well-considered consolidation loan can be the best way to go. If, on the other hand, you’ve already missed few payments and you’re seeing no way to get things back on track, a settlement program can help you start over again.
Long story short, it all depends upon the nature of your situation.
