NEW-YORK – May 7, 2022 – (
If you’re struggling with debt, you’ve probably researched repayment options. Two of the most popular ways to get rid of debt fast are debt consolidation and debt settlement. But when it comes to settling debt, there are a few things you need to consider because the two have very different outcomes.
What is debt consolidation?
Debt consolidation is when a person combines several debts into one large loan. This can save a lot of money since the interest rates on debt consolidation loans are generally lower than the interest rates on individual debts. Debt consolidation can also help you reduce your debt repayments, which is especially important if you have high-interest debt.
What is debt settlement?
Debt settlement involves negotiating with your lenders to reduce the amount of money you need to repay. This can be a good option if you are struggling to pay off your debts and want to see them go down. However, debt settlement can also have negative consequences, including increased interest rates and lower credit ratings.
Also, settling the debt can have unintended consequences when it comes time to file your tax return. Because you used currency (credit) to buy things but didn’t pay it back to your original creditor, the IRS will consider your settlement balance as income. This can lead to significant penalties and tax bills, especially if it puts you in a higher tax bracket.
When should you use debt consolidation rather than debt settlement?
Debt consolidation is generally a better option than debt settlement if you have multiple creditors that you need to repay. Debt consolidation can lower your payments and potentially save you money on interest rates. If you’re not sure if it’s worth it, consider using a debt consolidation calculator to crunch the numbers.
One of the downsides of debt consolidation is that it can cause your credit score to drop temporarily due to the strain on your credit report. However, the decrease in your credit utilization ratio should offset this temporary impact on your score. Most debt consolidation loans also require direct debits from your bank account. If you end up not being able to keep up with your payments, it could lead to additional debt, overdraft fees, and greater financial hardship.
Debt settlement, on the other hand, is a good solution when there is only one creditor to whom you are indebted and you need to find a solution to your financial difficulties. However, the settlement may have negative consequences, including an increase in interest rates and a decline in credit ratings. Additionally, settling the debt can have unintended tax consequences since the IRS considers it income.
Are there options other than debt consolidation and debt settlement?
There are a number of other options you can explore, such as working out a payment plan with your creditor, working with a credit counselor, or filing for Chapter 7 bankruptcy. You can also consider adding more sources of income to your finances through side gigs or second jobs, adjusting your budget, cutting unnecessary expenses (even if only temporarily until your debt be reimbursed) or ask friends and family for help.
The bottom line
Debt consolidation can be a great option for some, while debt settlement is more convenient for others. It is important to weigh the pros and cons before making a decision.
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Credello: When should you use debt consolidation or debt settlement?