Turbo Takeaways
- Debt settlement and debt consolidation are both debt management strategies that can help you reduce your debt load, but they both work very differently.
- With debt consolidation, you’ll pay off your debts with a new credit card or loan, ideally at a lower interest rate. Debt settlement involves negotiating with your lender to pay off debts for less than you owe, often by up to 50% less before fees.
- Deciding between debt settlement vs. debt consolidation will depend on your credit score, your ability to repay, and many other factors.
What is Debt Settlement?
Pros
- Helps save money by paying a portion of original debt, potentially saving up to 45% before fees.
- May help you avoid serious consequences like bankruptcy.
- You can negotiate debt settlements yourself instead of hiring a professional. Being disciplined in saving for a lump sum can help you get out of debt faster.
Cons
- Lenders are not obligated to accept the settlement offer. If they refuse, you’ll be on the hook to clear your entire balance.
- Once lenders realize you’ve stopped payments, they may sue, get a court judgment, and garnish wages.
- Forgiven debt is taxable, so you might owe taxes on your settlement savings.
Debt settlement involves negotiating with your lenders to pay off debts for less than you owe. You can negotiate settlements on your own or hire a company to negotiate on your behalf.
Typically, you’ll need to stop making payments to your lenders and use that as leverage when negotiating a settlement. The idea is that lenders would prefer to settle for less rather than not get anything.
What is Debt Consolidation?
Pros
- May reduce your monthly debt payments. With a new loan, you may be able to choose a longer term and spread out the costs to make the monthly payments more affordable.
- Combines multiple debts into one monthly payment.
- If you qualify for lower interest rates, you may be able to save a lot of money.
Cons
- Allows you to move balances, but you’ll still have to make full payments. It doesn’t make the debt go away.
- Needs a good credit score to qualify for the best debt consolidation loans. With poor credit, you may not get loans or credit cards at lower rates.
- If you’re not mindful of interest rates and fees, such as transfer fees, application fees, and origination fees, it may negate any benefit you can get from consolidating your debts.
Debt consolidation involves borrowing money at a lower interest rate to pay off high-interest credit cards and other loans. Consolidating debt will reduce your monthly payments to a single, manageable amount.
Additionally, a debt consolidation loan can help you save on interest charges. You can consolidate your debts through consolidation loans, balance transfer credit cards, and home equity lines of credit.
Debt Settlement vs. Debt Consolidation
Here's a breakdown of how debt consolidation and debt settlement compare:
| Debt Consolidation | Debt Settlement | |
|---|---|---|
| How It Works | Take out a loan big enough to repay current debts; Make single monthly payments to the new lender | Enroll debt with a settlement organization; Monthly payments go to savings; Organization negotiates a lump-sum payoff |
| Typical Completion Time | 1 to 7 years | 2 to 4 years |
| Requirements | Favorable credit score and history | Ability to make monthly payments |
| Average Savings | Varies depending on interest rates, current debt, and loan APR | Savings of up to 45% of total debt (before fees) |
| Fees | Loan origination fees | Up to 25% of enrolled debt |
| Benefits | Reduces your interest rate | Reduces what you owe |
| Drawbacks | Resets and extends debt payments for the length of the new loan | Debt forgiven through settlement could be taxable |
| Impact on Credit | Score minimally impacted with complete, on-time payments | Score drops during settlement, but likely rises again after process |
| Best For | Modest high-interest credit card balances | Large, delinquent credit card balances |
Which Option is Better for Your Financial Situation?
The main difference between debt settlement vs. debt consolidation is that with debt consolidation, you’ll still need to pay off your entire balance. But there are several other factors you need to consider before you can decide which option will be better for you.
You can also get in touch with a credit counseling agency to understand your options. TurboDebt also offers a free consultation to help you determine the right debt relief solution for your needs.
Factors to Consider for Debt Settlement
Debt settlement is a good option for you if:
- You have maxed out your credit cards.
- You’re finding it challenging to make payments.
- You have accumulated late payment fees.
- You have missed payments for several months.
- You already have bad credit due to poor repayment history.
- You are willing and able to save a lump sum amount for the settlement.
Factors to Consider for Debt Consolidation
Debt consolidation is a viable strategy for you if:
- You have multiple debts, such as credit cards and personal loans.
- You have good credit that allows you to get qualified for lower-interest loans.
- Having a single payment each month may benefit you.
- You have the ability to make payments each month.
- You are disciplined enough to stick to timely payments for the duration of the loan.
Pursuing Debt Settlement or Debt Consolidation
Now that you have a deeper understanding of the key differences between debt settlement vs. debt consolidation, it’s time to take a closer look at how each of these debt management options works and the steps involved in the process.
Steps to Pursue Debt Settlement
With debt settlement, you have the option to negotiate credit card debt on your own or hire a professional to negotiate on your behalf. Listed are the steps you’ll need to follow:
- Start by saving money that you can offer as a lump sum payment to your lender.
- Get in touch with your creditor to start the negotiation process. Start with a lower offer and adjust the amount if they come back with a counteroffer.
- Get any agreement details in writing. Send your payment through a safe, traceable mode of payment.
- If you’re working with a debt relief company, you’ll need to set up a separate bank account and stop paying your lenders.
- Start saving money each month in the bank account. You’ll continue to put aside money until you have enough saved up for a settlement.
- The debt settlement company will negotiate with your lenders and make an offer. Once they’ve reached an agreement and you have enough money saved, they’ll pay the lender to settle the account.
Steps to Pursue Debt Consolidation
Debt consolidation is straightforward, but you’ll need to put in enough research time and compare your options to ensure that you’re getting the lowest possible interest rates. Here’s how to get started:
- Take a look at your finances to determine how much debt you have, interest rates on each debt, repayment terms, and your credit score.
- Decide which consolidation method works best for you. For example, if you don’t have a large amount of debt, a balance transfer card may be right. IA personal loan may be a better option for longer repayment terms. And if you are a homeowner, a home equity loan (HELOC) is also another solution.
- Shop around and compare loan options based on interest rates, repayment terms, and fees. With balance transfer credit cards, for example, you’ll need to compare transfer fees.
- If you plan to get a personal loan, prequalify to get a better understanding of the terms you qualify for.
- Select a lender based on rates, fee structure, and repayment terms.
- Make sure you have documents like identification, proof of income, and other proof of address. Send in your application either online or in person.
- Once your loan or credit card is approved, use the funds to pay off your current debts. You’ll then need to stick to the debt repayment plan until you are debt-free.
Legal Considerations for Debt Settlement and Debt Consolidation
Another important consideration before you choose between debt settlement and consolidation is the legal risks involved in both these options so you can make an informed choice.
Legal Risks of Debt Settlement
You’ll typically need to stop making monthly payments to your lenders if you plan to settle your accounts. When you miss payments, you’ll likely start receiving collection letters and calls. When you don’t respond to them, debt collectors may decide to sue you for the amount you owe. This means that you stand at risk of wage garnishment, court-ordered payments, and other consequences.
If your settlement offer is accepted, any amount that your lender forgives is considered taxable by the IRS. You’ll need to report it when you file taxes and pay the appropriate taxes on that amount.
Legal Risks of Debt Consolidation
Debt consolidation doesn’t involve any direct legal risks, since you’re still paying your lenders the entire amount you owe.
An important point to remember here is that once you take out a new loan, you’ll have to make sure you make the monthly payment on time each month. Defaulting on the loan and missing payments can result in not only late fees and penalties, but your lender may also start debt collection efforts and decide to take legal action against you.
If you’re looking for ways to get out of debt and save money in the process, debt settlement and consolidation are both effective methods. But they aren’t the only solutions.
The best way to decide which option is best for your individual needs is to seek professional guidance. Fortunately, TurboDebt® can help. Our team will offer you a personalized debt relief option based on your individual needs.
Get in touch with us for a free consultation today.