Debt Settlement vs. Debt Consolidation

A term that people often confuse with debt settlement is debt consolidation. The two terms are used interchangeably, when in reality there is a significant difference between the two. While debt settlement refers to actual negotiations with your creditors in an effort to convince them to modify the terms of your loan agreement with them, debt consolidation makes no such negotiations. It may be possible to both consolidate debts and have them settled but this does not happen very often.

What is Debt Consolidation?

Debt consolidation is different than using your debt settlement currency to pay off modified debt, instead it is the process of securing a new loan with a balance sufficiently high enough to pay off your other debts. For example, if you have seven credit cards and a total of $8925.00 charged on them, you might, in order to consolidate your debt, take out a new loan or credit card with a $10,000 limit and then use the balance transfer feature of that card to pay off your other seven credit cards. The end result of this consolidation is that you now have only one card to pay off each month and it probably has a much lower interest rate than you were paying among the other credit cards you had. This saves you money over time as you pay down your debt in the form of interest payments, late fees and possibly over-limit and other fees as well.

Which Debt Solution is Better?

Since using debt settlement currency to pay less than you originally owed on a debt brings a loss to the company compared to what you signed for, there is usually a negative hit on your credit record once the settlement negotiations are complete and repayment begins. In the long run, you save plenty of money however, if proper negotiations have been made on your behalf. Debt consolidation, on the other hand, has no such negative effect on your credit, in fact it may have a positive effect on your credit, if done properly because a new credit card will increase the overall credit available that you have and lower your credit usage ratio. In our example above, if you had seven credit cards totaling $10,000 available credit and had spent $8925.00 between them all, that represents nearly 90% of your available credit being used. That is extremely bad as far as this part of your credit score and credit rating go - most lenders like to see that ratio at 25% or less. If you took out a new credit card for $10,000, however that immediately doubles your available credit limit to $20,000 and lowers your total usage to more like 45%. Still not great - but much better than 90%!

The downside to debt consolidation compared to debt settlement is that it requires that you still have a good credit score and are able to convince a lender to loan you enough money in your financial situation, in order to pay off other debts. Most people who come looking for a debt management solution have taken some hits to their credit already in the form of late payments or defaults, or have lost their employment, and securing a new loan is either impossible or unwise.