When it comes to dealing with debt, there are a couple of different financial strategies you can use to resolve it. These financial strategies, or debt relief plans, come in various forms. They can be something as simple as credit counseling, or they can be as extreme as filing for bankruptcy. While there are multiple debt relief options available, the two most popular types of debt relief are debt consolidation and debt management programs.
Both of these financial strategies aim to alleviate some of the debt load and stress of the debtor by eliminating collection calls, securing lower payments, offering credit counseling, handling negotiations with your creditors, and more. Each one of these solutions can simplify the process of settling debts in their own ways. However, it is important to note that despite the fact that the terms are sometimes used interchangeably, they have a very different approach to tackling debt. One aims to reduce your debts, while the other aims to replace your debt with a loan. In order to decide which of these two strategies is best for you, it is best to understand how they function and how each affects your credit.
Debt Consolidation
In times of financial hardship, many people end up owing money to multiple creditors, resulting in late payments and bad credit. This is usually a result of people taking on more credit to make ends meet. While these debts can be useful for making it to the end of the month, they can end up costing you your peace of mind later on. When tragedy hits and your income is limited, the constant stress of receiving bills can become tedious. Once you take into account the multiple other bills you receive at home, such as utilities, cell phones, rent, cable, etc. you realize the amount of stress this can generate. If you are struggling to keep up with bills that have critical due dates from multiple creditors and financial institutions, then debt consolidation or debt management may be the right debt relief for you.
Debt consolidation is the process of merging multiple bills into one single expense. Many people report experiencing less stress when dealing with only one bill a month, as opposed to several. This simple task of consolidating debts can not only provide some psychological benefits, but it can provide other benefits as well. Depending on the circumstances of your consolidation plan, you might be able to lower your total monthly payments, secure a lower interest rate, lower payments on the amount of debt you owe, and avoid making late payments and incurring fees. However, it is important to note that debt consolidation tends to be a lengthy process. It can take anywhere from three to five years to pay off the new loan completely. This means that people with debt must go into debt consolidation thinking of the long run. With careful planning, discipline, and patience, their debts will eventually be paid.
It is also important to say that debt consolidation is also referred to as “credit consolidation” or “bill consolidation.” Regardless of the label on it, the end goal is for debt consolidation to simplify the process of paying your creditors. It takes away the hassle of sorting through your bills, worrying about due dates, and the stress of wondering if you missed a bill this month. Instead, there is one payment to one source, once a month.
Pros and Cons of Debt Consolidation
If you are considering consolidating debts, then understanding debt consolidation, along with its pros and cons, is important.
Pros
- Makes things more convenient – Consolidating all debts into a single payment is extremely convenient. It means a lot less paperwork and only dealing with one financial institution.
- Can help you save – If you are able to find a debt consolidation plan with a lower interest rate, then you will end up saving some money. In addition, you can even save on charges and loan fees that you would have lost paying different creditors.
- Long term credit score benefits – While consolidation has a temporary negative impact on your credit score, it does not need to permanently affect it. If you are disciplined and consistent in your approach, you can actually work your way back to your initial score.
- Getting rid of collection calls – As we said, one of the biggest downsides of debt with late payments is the constant harassment from creditors. Consolidating debts provides the benefit of reducing the number of calls you receive.
Cons
- You could pay more interest overall – While consolidation can offer lower interest rates, they tend to last longer. This means that your monthly payments might be reduced, but the overall amount you pay on interest can be higher.
- Debt consolidation fees – While debt consolidation services are designed to help people save money, they still need to charge a fee for their services. This means that you will probably have to pay some fees for the services on top of loan interest.
Debt Settlement
Debt settlement aims to pay off a debt for a smaller amount of money than the initial balance owed. This is usually completed by the time that the debtor and the creditor agree to settle a debt for a fraction of the amount owed. Often, it is possible to settle a debt in monthly installments. In other cases, the settlement will involve a large lump sum payment. Debt settlement professionals will structure settlements to fit your monthly cash flow. The prospect of settling a debt for a smaller amount of money is appealing to people who find themselves struggling financially, and it is a tried and true method of reducing debt relatively quickly.
Many people who find themselves in debt come to the point where they struggle to even make minimum payments. This can lead to extreme sacrifices that drastically affect their quality of life. In situations like this, creditors might accept settling a debt for less money in an attempt to avoid losses down the road. It’s also a tax writeoff for the creditor. Accepting a smaller balance is more beneficial than having a debtor never pay back the amount owed or initiating lengthy and costly legal proceedings to try to collect if a consumer defaults.
Pros and Cons of Debt Settlement
While the prospect of saving lots of money sounds appealing to most, there are pros and cons to debt settlement, as with anything. These are the pros and cons of settling a debt.
Pros
- Settle for less – You don’t need to pay off the total amount of money owed on a debt. Once you have come to an agreement with creditors and have received it in writing, you can pay off the agreed-upon amount and consider the matter settled. Just remember there is still the matter of fees and interest that you need to cover as well. Fees and interest typically freeze once a settlement is reached, and are usually a drop in the bucket compared to the amount saved.
- Less interaction with creditors – If you are working with a professional debt settlement agency who will manage negotiations with the creditor on your behalf, then you will have much less interaction with banks and card companies. This can mean fewer stressful phone calls and peace of mind while the problem is handled by experienced professionals. You also have the luxury of one monthly payment as with debt consolidation.
Cons
- Credit score can take a hit – The process of settling a debt involves withholding payments until a settlement is reached (most people considering this option on are the verge of default anyway). This means that your late payments will be reported to the credit card bureaus, which will negatively affect your credit score. Thankfully, with the revised FICO scoring model, possessing zero debt on your books can help outweigh any missed payments.
- It can take a while – Debt settlement is not a quick fix solution. The process can take anywhere from 2 to 4 years to get settled. As a comparison, staying with minimum payments takes an average of 30 years to get rid of credit card debt, so it’s still much faster, relatively speaking.
- Fees and expenses – Despite the fact that you are lowering the overall you owe, you might still end up paying taxes on the amount of debt saved. Speak with your CPA about form 982J, as many are exempt from these taxes
- You could be sued – Aggressive creditors may decide to sue as a negotiation tactic. It’s rare, and reputable debt settlement companies know exactly how to deal with such a situation. However, sometimes the original shock of a lawsuit can affect emotions in the short term. Most lawsuits end up in settlements, however, without anyone stepping foot in a courtroom.
- No guarantees – While debt settlement programs are a popular form of debt relief, it is not guaranteed. Creditors are not obligated to settle for lower fees. Certain creditors do not even consider the option. A reputable debt settlement company will only accept clients who owe money to creditors that they have a proven history of settling in the past. Most creditors do participate in the process because it’s beneficial to them, too.
If you are determined to turn around your financial situation, it is important to come up with a game plan. Consider your current financial situation and see which option makes the most sense to you. Understanding debt and the options you have to reduce your debts can mean the difference between saving money and filing for bankruptcy. If you are having trouble choosing the best form of debt relief, then consider reaching out to professionals. Churchill Credit Solutions is here to help you resolve your debts in the most beneficial way possible.
