There are many reasons why people fall into debt. These can be from necessary expenses such as hospital visits, fixing a car when it breaks down unexpectedly, or home repairs that need to be done. No matter the reason, it’s easy to get behind if you don’t have the money. Debt consolidation and debt settlement are some of the more popular ways for people with debt to dig themselves out. Before deciding on what to do next, you need to find out the difference between the two options.
1. Credit Card Interest Rates
The main difference between debt consolidation and debt settlement is how they affect your credit cards. Debt consolidation means that you take out a new loan with which you pay off your existing credit card balances, usually at either zero percent or low interest rates.
This leaves you with one payment per month and allows you to pay off the debt faster. People usually find time limits important when they think about ways to reduce credit card debt because they want to pay off all their debts in a certain time frame. Most financial institutions will allow you to consolidate credit card debt, without negatively affecting your credit rating.
When you opt for debt settlement, you contact your creditors and negotiate a lower balance or interest rate. This often results in many different payments, taking longer to pay off the full amount of debt. While this may not affect your credit score, it could turn out to be more expensive in the long run because you may have to pay more money in fees. No matter what option you choose, it is important to make sure that you consolidate your debts responsibly and in a way that will help you get out of debt faster. Setting up an effective budget and being realistic about how much money you can contribute to paying off your debt every month will be key to overcoming your financial struggles.
2. Availability Of Funds
Another difference between debt consolidation and debt settlement is whether or not your credit cards are available to use after your debts are repaid, which depends on how they’re settled.
With debt settlement, you’re not allowed to use your cards while negotiating new terms with the creditor. This means that you will need to save up for essentials like groceries, rent, bills, and transportation until your debt situation is resolved. There are ways to avoid this like setting up a separate bank account for your bills and essentials.
With debt consolidation, after you have repaid all your credit card debts using a new loan, you are free to use your cards again. Keep in mind that it may take some time to rebuild your credit so be sure to use the accounts responsibly.
3. Legal Implications
Debt settlement is not legal in all U.S. states, which means that when you use this process to repay your debt, there could be negative consequences if the creditor decides to take you to court over unpaid debt.
You should always check with a lawyer or financial professional before deciding to settle debts with a creditor. Debt settlement is legal in most states, although there are some that have rules against the process, so it’s important to research this option carefully before using it. There are also no written rules for how debtors should act with a debt settlement provider.
With debt consolidation, there are legal limits and written rules about how the process should go. This reduces the chances of problems between you and your credit card company such as receiving lawsuits or demands for repayment after you’ve repaid your debts in full.
4. Tax Implications
Debt consolidation and settlement affect taxes in different ways. Debt settlement does not have tax implications while debt consolidation can have a negative impact on your taxes.
If you use a loan to repay your existing debts, any interest you pay on the new loan will be considered taxable income by the IRS. You can deduct these interest payments if you itemize your deductions. If you decide to use tax relief services to help with your debt consolidation loan, the IRS may consider this as income and charge you taxes on it. You should always check with a professional before deciding how to handle debts that are negatively affecting your ability to pay taxes.
5. Credit Score
When you use debt settlement to repay your debts, there is a possibility that the negative information will stay on your credit report for up to 7 years. This may make it more difficult for you to get loans and other lines of credit in the future.
With debt consolidation, you are taking out a new loan to repay your old ones. It is possible for this loan to show up on your credit report as another account that you have with the lender. This can help improve your credit score because it shows lenders that you pay your bills responsibly.
One benefit of debt consolidation is that you are able to keep your house if it’s in foreclosure. This can be beneficial if you want to stay in the home or sell it quickly, but it does mean that there may be additional interest on top of what you owe already.
If you choose to use debt settlement, your creditor will expect the amount of money you owe to be paid in full, which means that you will likely lose your house if you can’t afford it. However, this process is not always permanent and many people are able to negotiate with the creditor to keep their home through debt settlement later on.
7. Credit Counseling
Some creditors require credit counseling prior to letting you enter debt repayment plans using debt settlement. The counseling will help you understand your current financial situation and the steps to take to improve it, which can make it easier for you to repay your debts later on.
Debt consolidation does not always include counseling, but there are some creditors that require this before they will approve consolidation loans. This helps you to work with a proactive lender that is familiar with your financial situation, which can make it easier for them to help you repay your debts.
While debt consolidation and debt settlement both offer a path to getting out of debt, there are significant differences between them. Before deciding on the right approach for you, it’s best to consider your financial situation and discuss these issues with an expert such as a lawyer or accountant to find the best way to handle your debts. Things can get a bit overwhelming at the moment, so write a list of questions you want to ask before choosing between debt settlement or consolidation so that you know what you’re getting into if you plan to go through with either of these options.