Debt Consolidation Vs. Debt Settlement

At some point in everyone’s life they will be in debt. That debt may be because of a mortgage, auto loan, student loans, or revolving balances. For most of these there is an end in sight as they begin with a specified amount of time to repay the debt. The exception is revolving balances. If we are not careful, those balances can just grow and grow until they feel completely unmanageable and out of control.

At this point some people will look into something called: debt consolidation companies or debt consolidation loans. A legitimate debt consolidation loan is simply applying for a loan with set terms and then using the money to pay off your revolving balances. If the loan has a low enough interest rate this could end up saving a lot of money in the long run as credit card interest rates can vary drastically. Once the revolving debt is paid off, you have just one set payment you make every month to then pay off the loan.

However, not all companies that call themselves debt consolidation companies and say they provide debt consolidation loans are on the up and up. Some are actually ‘debt settlement’ companies. Debt Settlement is a completely different animal. These companies are wolf in sheep’s clothing and can end up doing a lot of damage to a consumer financially, not to mention the damage it can do to a consumer’s credit scores.

How does debt settlement work? Normally a debt settlement company will have you stop paying your credit cards for six months. Instead, you make monthly payments to a separate savings account set up by the settlement company. At the end of the six months the company will call the creditors and try to set up an agreement to pay the debt for less than what is really owed. Most credit card companies will agree to do this as they will at least be able to recoup some of the debt. If there is not enough money in the savings account to cover the settlement you will continue to pay into it until there is.

If you have multiple credit cards, the company will most likely deal with only one credit card at a time. The process is that: you will stop paying one card for six months, the company then settles the debt, and then moves on to another card using the same process. If a consumer has several credit cards, this process could end up taking years.

So… in this case, what happens to your credit? Your credit scores will take a nose-dive. You are first accruing late payments when you stop paying the cards, and second once you haven’t paid for six months the cards will go into a charged off status which is a double whammy as far as your credit scores are concerned. But this is what opens the door for the company to negotiate a settlement agreement. That “charge off” will stay on the credit report for seven years. This means that if you have four or five cards with only one being settled every six months, you are looking at a new charge off hitting your credit report twice a year. Given that, it could take years for your credit scores to recover. There is also the fact that the settlement company will take a fee between 20-25% of the debt. For example, to settle a $6,000 credit card debt the company could take $1,500.

Another way some companies operate is to negotiate lower payment amounts for the existing balances. This is something to be wary of as well. If you are not making the full payment required, the credit card companies will still report you late every month even if they have agreed to lower payment amounts.

Bottom line is to only consider debt settlement as a last resort. Debt consolidation is always a better option. If you have a lot of credit card debt, try to negotiate with the credit card companies yourself for a lower interest rate which will lower the payment amount. It is a good idea to transfer any balances from the high interest rate cards to one with the lowest interest rate. If you own your home, you could look into taking out a Home Equity Line of Credit to pay off the debt since those normally have very low interest rates.

You are the one in control with an actual debt consolidation loan. However, with a debt settlement company, you are placing your financial security in the hands of someone else. Whatever you decide to do, research the company you are thinking about using. Check with the Better Business Bureau and look at reviews, because not all debt consolidation companies are what they claim.



Author: Mindy Leisure Manager of Rescoring Services
Mindy has been with the company since it’s inception in 1994. She wears several hats as Director of Product Development and Rescore Express Manager. As a public speaker she has delivered dozens of seminars for borrowers, real estate agents and mortgage brokers on the ins and outs of the world of credit. Prior to joining Advantage Credit she had 15 years experience in mortgage, real estate and property management. Her experience, knowledge and dedication have helped make Advantage Credit a leading credit reporting agency. Mindy has a BA from Fort Lewis College in Durango CO and an MFA from Humboldt State University in Arcata, CA. After living for 32 years in Colorado she has recently moved back to where she was born and raised in Bartlesville, Oklahoma in order to be closer to her family. In her free time she loves to cook, fish, garden, write and spend time with her family and her dogs Ben and Annie.