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Debt consolidation and debt settlement are usually presented as easy ways for consumers to get out of debt, but the truth is that these processes can be complicated and it can have some serious consequences. Anyone who is considering this process should make sure they are aware of their options and how each of those options can affect their credit score, monthly bills, and ability to get a loan in the future.
Debt consolidation is usually a months or years long process in which someone replaces most or all of their high-interest rate loans with lower interest rate loans. Debt settlement, on the other hand, usually involves negotiating with creditors in order to have the interest rates and/or balances of a person’s debt lowered. Both methods usually start with debt counseling.
Debt counseling is a process in which a financial professional evaluates a person or family’s financial situation. During the debt counseling process, the counselor will look at the family’s bills, personal circumstances, and income and help their client to draw up a workable budget. In many cases, however, debt counseling alone cannot solve a person or family’s financial problems. In these situations, debt counseling can turn into debt consolidation or debt settlement.
If a family or individual has a lot of debt that they cannot comfortably pay off in a reasonable amount of time, the counselor will probably suggest debt consolidation. In this process, the consumer will work with the counselor to find a lower interest loan that can be used to pay off the balances on his or her high-interest debt. Depending on the financial circumstances of the person, the loan might be refinanced several times before the debt is gone. The idea is to lower the amount paid in interest and the total monthly payment that a consumer makes on his or her debt. This lowers the monthly bills of the consumer, allowing them to get back on their feet and get out of debt.
If the consumer does not qualify for any loans with a lower interest rate, however, the credit counselor might recommend debt settlement. In this case, the consumer (usually with the counselor’s help) will negotiate directly with their creditors to get a lower interest rate, balance, or monthly payment. In many cases, the consumer and/or counselor will have to tell the creditor that they need to accept a deal or risk the consumer falling into bankruptcy and having the debt completely charged off. While this is a more aggressive strategy, it can be very effective at helping a consumer who has very few other options.
It should be noted, however, that there are consequences to each of these methods. Credit consolidation has the benefits of paying a lower interest rate and a lower monthly payment, but in some cases, these things come at a cost of accepting a longer payment term. This means that instead of having debt paid of in a few months, the debt will probably be paid off in a few years. In the short term, this can be the help that a consumer needs to get a budget in order, pay off large bills, and/or wait out a period of unemployment. In the long term, however, this can cause a consumer to pay more on the debt. Fortunately, debt consolidation tends to have a negligible or positive effect on a credit score. As each loan gets paid off on time, a credit score will tend to go up.
Debt settlement can usually lead to the consumer having to pay less on his or her loans, but it can also have a really negative effect on a credit score. Because this process usually involves a creditor having to take a loss on a portion of the debt, banks and lenders who know a person has gone through debt settlement tend to not want to work with that person. They will also mark the debt as a charge-off on a credit report, causing a credit score to fall. The process is a lot easier to recover from, however, than a bankruptcy, and dealing with creditors head on rather than hiding from a collection agency is a lot less stressful.