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Debt consolidation vs debt settlement

Debt consolidation vs debt settlement
(Image credit: ShutterStock)

When it comes to settling debts you are struggling to repay, the different types of financial services on offer means it can feel overwhelming to find the right solution. For clarity, here are some of the differences between two of the most popular solutions: debt consolidation, and debt settlement.

Debt consolidation: How does it work?

Debt consolidation consists of taking out a single loan that you use to pay off several smaller debts, and we have a guide to the best debt consolidation companies (opens in new tab). These debts are usually unsecured debts such as credit cards, but there are products available for secured debt such as car loans. Average rates for these loans vary between 6% and 18% APR if you have good credit, but can be much more expensive if you have a lower FICO score.

When considering taking on a debt consolidation loan, it’s important that you add up the total amount you will repay, and compare it to the total amount you would repay without the loan.

Whilst the monthly payment and APR may be lower than your current debts if the term is longer you could end up paying more back. Consolidation is popular for those with multiple credit cards. If you need more advice here, check out our guide on how to pay off credit card debts (opens in new tab).

Top debt settlement provider

National Debt Relief is our top pick of debt settlement providers. As well as providing debt settlement, their debt councilors will also help you understand your debt management options.

There are some risks associated with taking out a consolidation loan. While these types of loans may make it more manageable to pay back your debt and will have less impact on your credit than other options like bankruptcy, there are still points to highlight. Some debt consolidation loans require collateral, meaning you could lose your car or home if you default on payments.

You also run the risk of extending the length of time your repayments last compared to leaving your debts where they are. Whilst this makes monthly payments lower, it could cost you more long-term. You will need to weigh up these differences before agreeing to a consolidation loan.

Bad credit and debt consolidation

If you have bad credit, you may still be able to find a consolidation loan provider that will take you on. You do, however, risk facing a very high APR. If you have been advised to take out a consolidation loan by a financial advisor, then you should shop around for the best rate you can find. Just make sure to utilize the online application forms that won't leave a mark on your credit file.

When choosing a debt consolidation provider, there are a few factors to take into consideration. One of the key indicators of a high-quality provider is industry accreditation. Some good accreditations include AFCC and IAPDA accreditation. Providers who are accredited must, among other things, train their advisors to a very high standard. This means that when you consult them for advice on your situation, they will be qualified to advise you regarding the best options for your circumstances.

Companies who offer debt consolidation loans are required to offer a certain amount of information upfront about the fees they charge, and the company’s history. This information must be shared in accordance with the New Rule (opens in new tab) from the FTC, and before signing up to any consolidation loan you should feel comfortable that you understand the ramifications of taking out the loan. If you have any questions, be sure to ask your advisor for help. Most companies offer a personal advisor, which is helpful for these kinds of questions.

You should also keep in mind that with a debt consolidation loan you will still be responsible for dealing with any calls or mail you receive from collection agencies. Your provider may be able to help you with information on how to deal with these, but until any loan is completely paid off you remain liable for it.

Debt settlement: How does it work

Debt settlement programs are a way of potentially reducing the amount of money you pay back to creditors. We have a guide to the best debt settlement companies (opens in new tab) too. As part of the program, you will stop paying money directly to your creditors, and instead will pay money into a dedicated account each month, for a period of time determined by your provider.

After this time has passed, the debt settlement company will negotiate with your creditors to agree on a lump sum payment to clear the debt. You will not be charged any fees upfront but will pay the company a percentage of the total debts entrusted to them once the process has been completed.

Signing up for a debt settlement program is quite simple, but it can be stressful because you will need to gather together all of your financial information so an advisor can give you accurate advice. The first step is to make a call to the provider and discuss your situation, if they think debt settlement is the right option for you, they will explain the process and help you sign up.

You then stop paying creditors and make deposits into your settlement account instead. The company then begins negotiations and will notify you when they receive settlement offers.

You then pay the creditors in a lump sum payment from the settlement account and pay the settlement company their fees. The process can take anywhere from a year to four years, and the time frame should be explained to you when you start the process.

Our top choice of debt settlement providers is National Debt Relief. Their debt counselors will advise you, in detail, on all your debt management options, so it's a good place to start.

Fees are always calculated on top of the settlement amount

Settlement costs vary depending on the company, and on your location. It’s important to always keep in mind that the company’s fee is always calculated on top of the settlement amount. So whilst you may end up paying $12,000 to settle a $30,000 debt, after a 20% fee you would pay $18,000 to clear the debt completely. It is often still worthwhile, but it’s important to keep fees in mind when considering settlement as an option.

One of the biggest drawbacks of settlement over other options is the amount of bad credit it can leave you with. Settlement companies can only negotiate on debts that are overdue, and by having overdue debts you are exposed to receiving bad credit. If you have plans for the future that include borrowing money again, and other options are available to you, settlement may not be the best move.

If you speak to an accredited provider you will be able to receive advice on this at the outset. You should always make sure you fully understand the implications of beginning a debt settlement process before signing up. And, in order to stay out of debt, we recommend considering how to borrow money (opens in new tab) smarter in 2020.

National Debt Relief

National Debt Relief is one of the best options for debt settlement. Customer service and debt negotiation are provided in-house, and its average rate of debt reduction is one of the highest we've found.

Gina Clarke has worked in journalism for over a decade for titles such as The Daily Mail, The Sun and Forbes. She began her career in BBC radio and now specialises in subjects such as financial technology and women’s health. She has written for the Top Ten Reviews brand on a number of different and varied topics.