If you are spending most of your earnings to pay your debt, then it’s time to become alert and re-consider your financial plans. There are various ways in which you can get relief from the debt that you are grappling with; but how do you choose what is the right method for you? Here is a comparative analysis on two of the most common methods – debt settlement and debt consolidation.
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Debt settlement
This is a process wherein the debtor (or a credit settlement company, on the behalf of debtor) negotiates with the creditor to reduce the debt by maximum possible amount or to get a discount on the total balance. On paying this amount, the loan is considered paid.
Benefits of debt settlement
- Instantly allows you to get a hold over your financial situation, as it makes you debt-free sooner than later.
- Saves you a lot of money since the agreed amount is much less than the total amount owed by you.
- Clears off your debt in about 2-3 years; so, it makes you stress-free quickly.
- A very good alternative to bankruptcy. There is still a negative impact on your credit score but the impact is less severe as compared to bankruptcy.
- No danger of losing a collateral as none is involved.
Drawbacks of debt settlement
- Damages your credit score severely (as compared to the debt consolidation route for closing debts).
- If you employ the services of a debt settlement company (which is very likely), then the fee you pay them for their services will add to your expenses and you can never be sure whether the debt settlement company will actually be able to sort it out for you.
- Various fake companies that are not interested in your welfare may actually get you further into trouble.
Favorable situations to pick debt settlement
If you are more than three months behind in making your payments and anyways have a bad credit score, it is a good idea to go in for debt negotiation. Yes, your credit score might be further hit and this might mean that you are not able to take loans in future; but your priority should be to get debt free in this scenario and not future loans.
Also, in a situation when an individual is close to bankruptcy and/or doesn’t have a property to use as collateral, negotiation becomes ideal.
If you are hiring a debt settlement company, keep a tab on the savings you are making against the service fee you are paying to the debt settlement company. A good company is one, which tells you how much you are saving after the payment of their fee; and also talks about the drawbacks of the debt settlement plan.
Debt consolidation
Consolidating various unsecured loans into one single unsecured/secured loan is called debt consolidation. A debt consolidation loan will generally be at a lower interest as compared to the cumulative interest rate on your current loans. Moreover, the consolidated loan might have easier payment terms. However, it also has its drawbacks. Let’s take a look:
Benefits of debt consolidation
- Helps you organize your finances and keep track of things… because you need to make only one single payment every month.
- You can get rid of all the collection calls, as all such communication will go to the debt consolidation company/counselor engage by you for debt consolidation services.
- As you make your monthly payments for the consolidated loan, you will also improve your credit score.
- In most cases, the debt is paid off sooner or the monthly payment amount is reduced.
- Reduces/eliminates late fee since the consolidated loan is structured to suit your budget. This helps get out of the debt spiral.
- Due to lesser interest rates, you will end up paying lesser amount to your creditors as opposed to the high rate interest payments you were making earlier.
- Minimal effect on your credit scores.
Drawbacks of debt consolidation
- Since the consolidation loans are generally secured loans (require collateral), you always run the risk of losing your collateralized asset in case you default on payments.
- Consolidation may lead the debtor to the possibility of not being able to discharge debts in bankruptcy.
- In case of credit card debt consolidation, you have to cancel all your cards on which you are consolidating.
Favorable situations to pick debt consolidation
It is best applicable for credit card debts as the interest rate on them is much more than the rate on most other loans. So, moving to a low interest loan e.g. a home equity loan makes a lot of sense.
Another good situation is when you have many small debts and find it really difficult to keep a track of them. So, getting a consolidated loan will help you get things straight and more manageable.