Knowing The Difference And Choosing Between Debt Consolidation And Debt Settlement

When it comes to debt relief, there are several options to choose from but most of the times people opt for either a debt consolidation loan or a deb

When it comes to debt relief, there are several options to choose from but most of the times people opt for either a debt consolidation loan or a debt settlement. However, if you are in a similar situation and are in a dilemma as to which option to choose, this article will help you a lot in that regard.

You will need to know the difference between the two options, the processes followed and the consequences as well. This will help you to make a more informed and educated decision.  

  • To start with, both debt consolidation and debt settlement are effective financial strategies through which you can improve your personal debt load.
  • Both will resolve different issues with their different ways of functioning.

If you consider both these debt relief options at the very basic level, you will see that:

  • Debt settlement option is useful if you want to reduce the total amount of debt owed to your creditor and
  • Debt consolidation an option that is useful if you want to reduce the total number of creditors and not the total amount that you owe.

However, both these strategies will provide you with a few secondary benefits but debt consolidation Pennsylvania will provide you with more of these benefits.

More about debt consolidation

Just as the name implies, a debt consolidation loan will allow you to consolidate or roll all your debts into a single loan account.

  • Such combination will replace all of your previous debts
  • You will now have to make only one monthly payment
  • The amount to be paid will be lower than the entire monthly amount of all your previous loans with one rate of interest and
  • The new loan will carry low rate of interest and longer loan tenure.

Consolidation loans are usually offered through banks and financial institutions such as credit unions. There is a new lender to whom you now make the monthly payments.

Consolidation loans offer a few psychological benefits at least to some borrowers as it reduces and simplifies the monthly payment. However, the money you save due to low interest rate may be offset due to its longer payment terms. Therefore you should consider the long term costs of a consolidation loan before taking out one.

Mostly, all consolidation loans are secured with any one of the following four assets of yours:

  • Your home
  • Your car
  • Your retirement account or
  • Your insurance policy.

Therefore, you should consider taking out such a loan only when you feel comfortable in putting up substantial collateral security.

About debt settlement

As opposed to debt consolidation option, a debt settlement strategy does not replace the old loan or loans with a new one. Instead, it involves a series of negotiations with your creditors, provided that allow, with or without the help of a credit counselor to reduce the total amount that you currently owe to your creditor.

  • The payment is made in a lump sum and at one time, meaning you will need to have a considerable amount of money in hand before you start with the negotiation process.
  • Though the creditors are under no obligation to enter into any new agreement with you, a successful debt settlement negotiation can offer you a chance to recoup a considerable portion of your loan.

This is a more feasible process both for the lender as well as the borrower. As for the borrower, there is no need to go through the lengthy and expensive process of bankruptcy and as for the lenders there is no need to spend a lot of money on advanced debt collection techniques.

A debt settled can wipe your account clan but if you settle unsecured debts such as credit cards, there is a risk that your card will be closed permanently after the settlement is complete since the lender will not want to grant you further credit and risk further loss of such kind.

Effects on credit score

No matter whichever option you choose, either strategy will have a lasting impact on your credit score. Therefore, it is required that you weigh the pros and cons of each carefully before you choose one of it.

In general, a debt settlement will typically have a greater negative impact on your credit score, though the magnitude of the impact will depend on a multitude of factors such as:

  • The current state of your credit
  • The reporting practices followed by your creditors
  • The amount of the debts being settled
  • The standing of your debts
  • The amount that has been reduced from the original outstanding balance and a lot of other variables.

If you ask why is that so even when you creditor are getting a large sum of money at one time, the answer is that strong credit scores are usually designed to reward only those accounts that are paid on time as per the original credit agreement before it is closed.

Since a debt settlement plan reduces the outstanding amount of the loan it in a way modifies or negates the original credit agreement and therefore, your credit score is affected in a negative manner. Other lenders will be wary about such mention in your credit score and will think twice before granting you a loan in the future.

Other points to consider

When you settle multiple accounts it will hurts more than settling just a single loan account. This is because multiple loan accounts will add up to large amounts and as it is with all debts, larger balances will have a proportionately larger impact on the credit score.

On the other hand, if you are settling small accounts and if you are current on the bigger loans then the impact on your credit score due to debt settlement will be negligible.

According to the rule, in your credit history the most weightage is given to the payment history and that is why you should try to be current when you go for a settlement. An account that is long overdue will have a drastic effect on your credit score.

The bottom line therefore is to consider the opportunity cost before making a choice between settlement and consolidation.