Written by: Amber Westover | Best Company Editorial Team
Last Updated: February 24th, 2020
E.E. Cummings once said, "I'm living so far beyond my income that we may almost be said to be living apart." When you are living beyond your means, your debt can easily take on a life of its own. Debt is an increasingly common part of life for many Americans. According to a study performed by the PEW Charitable Trusts, 8 in 10 Americans have debt (most commonly mortgages), and 7 in 10 say that debt is a "necessity in their lives."
Debt can leave you feeling both overwhelmed and enslaved, especially since the average debt for a balance-carrying household is $16,048. There are many strategies and options for managing and paying off your debt. Depending on the severity of your debt, this can be an intimidating and discouraging process. Many companies offer debt consolidation and debt settlement services to help you manage your debt. While both services help manage debt, there are some important and distinct differences.
What Is Debt Consolidation?
Debt consolidation is the process of combining all your debt into one simple payment. It usually involves taking out a new personal loan or working with a respectable credit counseling agency. You still pay off all your debt, though usually under more favorable terms. Applicants who achieve lower interest rates may be able to pay off their debt more rapidly.
Debt consolidation, if used properly, can help your credit score long term, if you pay off your debt consolidation loan in a timely manner. However, if you miss payments or close all of your accounts immediately after paying off your debt, your score could be negatively impacted.
Is It Right for You?
Debt consolidation is a great option if you have high-interest rates on your current debt. This is especially applicable to credit card debt. The average credit card APR in March 2017 was 15.59 percent. Companies such as Consolidated Credit offer an average APR of 6 to 10 percent.
It may also be a good fit if you have high monthly payments. Debt consolidation allows you to achiever better repayment terms. A lower monthly payment makes it easier to stay on top of your debt and prevents you from accruing late payment penalties.
Debt consolidation is usually best for individuals with good credit scores. A good credit score will allow you to receive the best possible interest rate if you take out a debt consolidation loan. A poor credit score may not provide more favorable terms than your current credit plan. Additionally, debt consolidation tends to have a less significant impact on your credit score than debt settlement. This is true with both consolidation loans and working with a credit counseling agency.
Finally, debt consolidation is a great option if you have an abundance of monthly bills. Debt consolidation provides the ease of one monthly payment to one creditor. If you only have one creditor, then you may want to consider other options such as a debt management plan or debt settlement.
What Is Debt Settlement?
During debt settlement, a company negotiates with your creditors to settle your debt for less than the original amount. Typically you will pay money into an account and that account will be used to pay your creditors. Often you are encouraged to fund the account, rather than pay off your balance. The company will then use this money and your lack of payments to convince your creditor to settle your debt.
Because you are paying less than the amount owed, there are usually more significant ramifications with debt settlement than debt consolidation. For example, your credit score and report are negatively impacted. According to the NFCC, your credit score could decrease by 65 to 125 points. After settlement, your debt is often marked as "Settled" or "Paid Settled" rather than "Paid in Full." This will show on your credit report for seven years. In addition, debt settlement has varying results. You can search for reputable companies who are ranked highly on sites such as BestCompany.com.
Is It Right for You?
If you cannot manage your debt through other alternatives, such as debt management programs or debt consolidation, debt settlement may be a good option. Top companies such as Pacific Debt Inc. recognize that debt settlement is not right for every circumstance. As a result, many debt settlement companies require a minimum debt amount, often over $7,500 or $10,000. If you have a smaller amount of debt, you may want to consider other options.
Debt settlement allows you to pay off your debt through one monthly payment. According to Freedom Debt Relief, it also allows you to pay off your debt faster than making minimum payments.
If you have a low credit score, debt settlement may be a good option. A low credit score may disqualify you from lower interest rate options. Debt settlement is also ideal if you are considering bankruptcy and have no means to pay off all of your debt. According to National Debt Relief, debt settlement programs tend to lower your credit score significantly less than bankruptcy, typically by half as many points. After debt settlement, with wise choices, you can rebuild your credit score.
Choose the Option that Meets Your Needs
There are many options for debt management. Remember to consider factors such as your credit score, the total amount of debt, and your present interest rates. Assess your individual circumstances to see if debt settlement or debt consolidation is right for you.