Debt consolidation and debt settlement are both debt relief programs. They are both financial strategies designed to improve both business and personal debt load, but they function quite differently and are used to resolve different issues. At a very basic level, debt settlement is useful for reducing the total amount of debt owed, while debt consolidation is useful for reducing the total number of creditors to whom you owe debt. It is possible to receive secondary benefits through either strategy, particularly debt consolidation.
Debt Consolidation is the process of “working with your creditors” to establish a more manageable payment plan over a long duration.
The business consolidates its debt through a consolidation loan, which is a single loan that combines and replaces all of your prior debts into one monthly payment with one interest rate. Consolidation loans are offered through financial institutions, usually banks or credit unions, and all of your debt payments are made to a new loan lender.
Most consolidation loans are secured with one of the company’s assets such as buildings, vehicles, insurance policy. The company should only accept a secured consolidation loan if it is comfortable with putting up considerable collateral.
Debt consolidation ends up being most useful for credit card debt since most credit cards come with high interest rates. If you can combine all into one, that’s ideal. But even if you can lower the interest rate on one of your credit cards, then you’ll be able to ensure more of your monthly payment goes straight to that principal balance.
Debt settlement is the process of offering a lump sum in one or just a few payments that is smaller than the outstanding debt.
Debt settlement can eliminate all or a portion of your outstanding debt but comes with a price, so it should be a last resort. Filing for bankruptcy is one way people choose to settle their debts and start over with a clean slate. However, the slate is not left very clean, as a bankruptcy is a huge black mark on your credit report that remains for many years. A slightly less burdensome option is negotiating a debt settlement arrangement with your lender in which you offer to pay less than what is owed. A debt settlement arrangement still causes a big drop in your credit score and, depending on how the lender reports the debt settlement to the credit reporting agency, could raise a red flag to lenders in the future.
Settling your debt requires you to either have money to settle the debt with (unless you can go into a hardship program and save money in the interim for the settlement) or to go to a debt settlement company that puts your monthly payments in escrow for you to settle later.
Deciding if you should pursue debt consolidation or debt settlement as your debt relief program will depend largely on the current state of your finances. Debt consolidation can be a good first step, while debt settlement is best used as a last resort.