Many Canadians are struggling under the burden of debt and looking for debt relief to help them get their finances back on track. Among the options you may have encountered while doing your research are debt consolidation and debt settlement. While both are designed to help you reduce your debt load, they do so in different ways.
Today, we will look at debt consolidation vs debt settlement, explain what they are, their differences and, of course, how to determine which might be better suited to your situation.
What Is Debt Consolidation?
The most common form of debt consolidation is the debt consolidation loan. During debt consolidation, you borrow money to pay off smaller debts, such as credit cards or other loans, typically at a lower interest rate. This allows you to consolidate your debt into one payment instead of multiple, making it easier to manage your debt repayment by eliminating different payments of different amounts to several creditors.
Typically, you apply for a debt consolidation loan with your financial institution or an online lender. Interest rates and terms vary widely between providers, so we recommend researching to ensure you find the best conditions for your situation instead of going with the first offer you see.
Consolidating your debt into one payment will not reduce the amount you owe, but it will make keeping track of your finances easier and also reduce the amount of interest you have to pay each month.
However, it is critical to remember that the most significant potential hurdle for a debt consolidation loan is your eligibility. You must have a good credit score and the financial means to cover the monthly payments. If your credit score is below the lender’s minimum requirement, the lender may ask for assets as collateral, such as your car or house, in case you default on the payments. If this happens, you may lose any assets you have pledged for your secured consolidation loan.
What Is Debt Settlement?
On the other hand, debt settlement takes the approach of negotiating with your creditors to pay off your debts for less than what you owe. To do so, you hire a debt settlement company that will negotiate on your behalf. Typically, the first step of debt settlement is withholding payments to your creditors. The debt settlement company will then use this nonpayment and leverage it against your creditors to negotiate a lower settlement amount, hoping that your creditor will instead settle for less than not getting paid at all.
This is a risky approach for many reasons. For one, withholding payments will seriously impact your credit score, as outstanding and overdue payments will be reported to the credit bureaus. It will show as late payments or nonpayments on your credit report. These notes will remain on your credit report even if the settlement is successful and lower your credit score, potentially impacting your ability to secure loans in the future.
Another risk is that creditors can withdraw from a debt settlement plan anytime, restarting the cycle of potential collection calls and emails.
Additionally, debt settlement will add between 15% to 25% of the total amount the debt settlement company is working with (this means the amount before any negotiations) and potential fees for administering the savings account you make your payments into. It is critical to note that even if the debt settlement is unsuccessful, the debt settlement company will still charge you their fee, so in the worst case, you may end up with more debt than you had before.
The Differences Between Debt Consolidation and Debt Settlement
There are two main differences between debt consolidation and debt settlement. In the former, you must pay off the entire principal balance, but typically at a lower interest rate and relatively risk-free. In the latter, you have the potential to reduce the amount you must pay back, but you incur additional costs, damage your credit score, and run the risk that your creditors may not accept the settlement. You also accrue more interest while waiting for the negotiations to take place.
When to Consider Debt Consolidation or Debt Settlement
Before committing to any debt relief option, you must determine if the choice is right for your specific situation.
Debt consolidation may be right for you when:
- Your credit score is good enough to get approved for a lower-interest loan
- You have several smaller to mid-sized debts such as credit cards, payday or car loans
- You could use the breathing room of reduced interest rates
- You could benefit from one payment versus several
On the other hand, debt settlement should generally only be considered as a last resort due to its risks and the damage it can do to your credit score. It might be a better alternative than bankruptcy, but it is still something to remember.
Be Debt Free, Talk to Chande Debt Solutions!
Choosing the right debt solution is critical to ensure it is the best solution for your situation. Remember, there’s no one-size-fits-all answer when it comes to managing debt. Each journey is unique, and finding the right path requires careful consideration and, often, professional guidance.
The experienced Licensed Insolvency Trustees of Chande Debt Solutions are focused on personal debt relief and insolvency services. They can help you prepare by examining all debt relief options and devise a strategy to resolve your debts. We know that filing a consumer proposal or bankruptcy is a serious matter, and we want to ensure that you are well-informed and don’t rush into any solutions. All of our consultations are free, without time limits.
Call us today at 416-366-3328 or fill out our convenient online form to learn how we can help you recover financially.
