Debt Consolidation vs. Debt Settlement – What Are The Main Differences?
There are many reasons people go into debt. These could be necessary expenses such as hospital visits, repairing a car in the event of an unexpected breakdown, or home repairs that need to be done. Whatever the reason, it’s easy to fall behind if you don’t have the money. Debt consolidation and debt settlement are among the most popular ways for people in debt to cope. Before deciding what to do next, you should know the difference between the two options.
1. Interest rates on credit cards
The main difference between debt consolidation and debt settlement is their impact on your credit cards. Debt consolidation means you take out a new loan with which you pay off your existing credit card balances, usually at 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 deadlines important when they think about ways to reduce credit card debt because they want to pay off all their debts within a certain period. Most financial institutions will allow you to consolidate your credit card debt without negatively affecting your credit rating.
When you go for debt settlement, you contact your creditors and negotiate a balance or a lower interest rate. This often results in many different payments, which takes longer to pay off the full amount of debt. While it doesn’t affect your credit score, it could prove to be more costly in the long run as you may have to pay more money in fees.
2. Availability of funds
Another difference between debt consolidation and debt settlement is whether your credit cards are available after you have paid off your debts, which depends on how they are settled.
With debt settlement, you are not allowed to use your cards while negotiating new terms with the creditor. This means that you will have to save for the most part 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 paid off all of your credit card debt using a new loan, you are free to use your cards again. Keep in mind that rebuilding your credit can take some time, so be sure to use the accounts responsibly.
3. Legal implications
Debt settlement is not legal in all states in the United States, which means that when you use this process to pay off your debt, there could be negative consequences if the creditor decides to sue you for an unpaid debt. .
You should always consult with a lawyer or financial professional before deciding to settle debts with a creditor. Debt settlement is legal in most states, although some have rules against the process, so it is important for research carefully this option before using it. There are also no written rules on how debtors should deal with a debt settlement provider.
With debt consolidation, there are legal limits and written rules on how the process should take place. This reduces the risk of problems between you and your credit card company, such as receiving lawsuits or requests for reimbursement after you have paid off your debts in full.
4. Tax implications
Consolidation and debt settlement affect taxes in different ways. Debt settlement does not have a tax impact, while debt consolidation can negatively impact your taxes.
If you are using a loan to pay off your existing debt, 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 you with your debt consolidation loan, the IRS may treat that as income and charge you taxes on it. You should always consult a professional before deciding how to handle debts that negatively affect your ability to pay taxes.
5. Credit score
When you use debt settlement to pay off your debts, negative information may stay on your credit report for up to 7 years. This can make it more difficult for you to get loans and other lines of credit in the future.
With debt consolidation, you take out a new loan to pay off your old ones. It is possible that this loan will show up on your credit report as another account that you have with the lender. It can help improve your credit score because it shows lenders that you are paying your bills responsibly.
One of the benefits of debt consolidation is that you can keep your home if it gets foreclosed. This can be beneficial if you want to stay in the house or sell it quickly, but it means there may be additional interest on top of what you already owe.
If you choose to use debt settlement, your creditor will expect the amount of money you owe to be paid in full, which means you’ll likely lose your home 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 afterwards.
7. Credit counseling
Some creditors require credit counseling before letting you get into debt repayment plans using debt settlement. Counseling will help you understand your current financial situation and what you can do to improve it, which can make it easier to pay off your debts in the future.
Debt consolidation does not always include advice, but some creditors require it before approving debt consolidation loans. This helps you work with a proactive lender who knows your financial situation, which can make it easier for them to help you pay off your debts.
While debt consolidation and debt settlement both offer a way out of debt, there are some significant differences between them. Before deciding on the right approach for you, it is best to examine your financial situation and discuss these matters with an expert such as a lawyer or an accountant to find the best way to manage your debts. Things can get a little overwhelming right now, so write down a list of questions you want to ask before choosing between debt settlement or consolidation so you know what you’re getting into if you are considering going through one. of these options.