Debt Consolidation vs Debt Settlement: What’s the Difference?

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If you are considering a debt consolidation or debt settlement, make sure you understand the differences between these similar sounding options. (iStock)

Debt can keep you awake, especially when you owe multiple creditors. If you have credit card debt, medical bills, and outstanding loans, it can be difficult to keep your monthly payments under control. If you want to pay off your debts by consolidating them, also known as debt consolidation, you can consider a personal loan.

In fact, one of the most common reasons borrowers take out personal loans is to consolidate debt. It’s a solid option, but when exploring ways to pay off your balances, it’s easy to confuse debt consolidation with debt settlement.

Whenever you are considering taking out a personal loan, you will always want to use a website like Credible to compare rates and lenders to make sure you get the best deal possible. Credible can help you get a lower interest rate, give you estimated monthly payments, and more.

Debt Consolidation vs. Debt Settlement: What’s the Difference?

While these terms may sound similar, there are some significant differences between debt consolidation and debt settlement that could impact your credit score. With that in mind, it’s important to read the fine print and understand each other’s terms so you don’t have financial problems.

Debt consolidation

In debt consolidation, you get a loan from a bank, credit union, or online lender and use the funds you borrow to pay off as much of your current debt as possible. Instead of making payments to various creditors, you will make one to your lender.

One of the main advantages of taking out a personal loan for debt consolidation is that you can benefit from a lower interest rate. For example, according to the Federal Reserve, the average interest rate for personal loans is 9.65%, which is lower than the average interest rate for credit cards of 14.65%.

You can visit Credible to explore your personal loan options and compare rates and lenders.

5 DIFFERENT TYPES OF PERSONAL LOANS TO CONSIDER

If you are able to lower your interest rate, your payments may be lower, leaving you with more money in your budget. You can also keep the same payment amount and pay off your debt faster with this lower rate.

Credible’s loan calculator can help you understand exactly how much a loan could cost you. You can also calculate the numbers using Credible’s free online tools, including a rate table that helps you find a lender who meets your personal finance needs.

HOW TO GET A DEBT CONSOLIDATION LOAN WITH BAD CREDIT

Debt settlement

Although you can try it yourself, debt settlement usually involves hiring a third party company that contacts your creditors and tries to negotiate a smaller lump sum payment on your behalf. These companies charge between 15% and 25% of the original amount owed after the debt is settled.

But before trading can take place, you must stop making payments for at least 90 days, which will damage your credit and your FICO score. At the same time, late fees and interest continue to rise. You can expect to receive threatening letters and phone calls from creditors during this time.

Most debt settlement companies require that you regularly transfer funds to an escrow account until you have accumulated a sufficient settlement amount. An independent administrator oversees this account and will likely charge a fee for this service.

While it is possible that your debt will be reduced, there is no guarantee that your creditors will accept a smaller lump sum payment. So you could end up owing a lot more than you started out with due to interest and penalties. If your debt is settled, the Internal Revenue Service considers the amount you are forgiven as income and, therefore, taxable.

For these reasons, a personal loan can be a better and less risky option. If this option sounds more appealing to you, head over to Credible, where you can learn more about debt relief options and what would work best for your financial situation.

9 OF THE BEST DEBT CONSOLIDATION LOAN COMPANIES

What if I sign up for a debt settlement instead of a debt consolidation?

If you find that you have taken out a debt settlement rather than a debt consolidation, cancel your contract with the debt settlement company in writing as soon as possible.

You are entitled to all funds held in escrow as well as accrued interest. You can then contact your creditors and notify them that you have canceled the agreement and are going to handle the debt on your own. You can also use nonprofit credit counselors to help you manage your debt.

HOW TO FIND THE BEST PERSONAL LOAN FOR YOUR NEEDS

How to rebuild my credit?

If you apply for a loan with bad credit, you will likely be refused or forced to accept a high interest rate. Replenishing your credit can seem daunting, but it can be done in just a few steps:

  1. Pay your bills on time and never miss any payments.
  2. Check your credit report. The Consumer Financial Protection Bureau recommends that you check your credit report at least once a year and report any inaccuracies that could negatively affect your score.
  3. Watch your credit utilization rate. Even if your credit limit is high, it is in your best interest to use less than 30% of what is available.
  4. Consider a secured credit card. This account requires a cash deposit, which is your credit limit.

If you are ready to restructure your debt, a personal loan offers a route to debt consolidation without the potential pitfalls of debt settlement. Start your application today.

DO I HAVE TO USE A PERSONAL LOAN TO CONSOLIDATE DEBT?

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