Both settlement and consolidation can lead you out of a debt loop. But each solution has a different impact, and understanding the differences between them is crucial for any business owner considering this type of debt management. Settlement is not consolidation. In fact, the two approaches don’t work at all alike. In short, consolidation means getting a loan and using it to pay off multiple debts at once. The loan, however, has to be paid back, and now it is the only debt. With settlement, you pay less than the full amount you owe.
Consolidation Is a New Loan
Debt consolidation works by taking out a loan and using the funds to pay off multiple debts. In doing so, you end up with a single loan (your debt consolidation loan), which is easier to track and manage. But in the real world, consolidation can have serious consequences. And it’s not without risk. Consolidation is a new loan. It doesn’t magically make your debts disappear, and you’ll be paying interest on a consolidated loan, which makes the entire situation more expensive.
Every penalty and point of inflated interest you have racked up is wrapped into the overall cost. That means that the balance of a consolidated loan is inflated, and debts won’t disappear as quickly as you might think. At the end of the day, consolidation doesn’t eliminate any debt. You’ll still have to pay back the original debts that were rolled up into the new loan. There’s simply no getting around interest. And the late payments that got you here are not forgiven. They stick to your credit history just as stubbornly as always.
One more warning: not every company selling consolidation is a lender. Some want to charge fees to run your consolidation plan for you. They collect your monthly payment, keep a part, and pass the remainder along to your creditors. In fact, they may even leave you worse off. Programs like that can push you into default and hurt your credit. Be careful! Not all lenders or brokers are the same. Use an accredited lending institution if you choose to consolidate. Think twice about a home equity loan or HELOC, too. You are using your home as collateral. If you consolidate that way and you default, you could lose your house.
Debt Settlement
Think of consolidation as simply moving your debt from one bank to another. Debt settlement, on the other hand, works quite differently. This is because, contrary to consolidation, settlement does not involve taking out a new loan. The process of debt settlement means paying less than the total amount owed. It’s a compromise between what you owe and what you can pay.
Settlement is a series of conversations between the debtor and the creditor. The focus is the principal. That is, the original amount you borrowed. By renegotiating the settlement amount, you can work with the debt owners to pay back what you can afford, while getting out from under the interest. Late payment fees can also be removed, along with the compounded interest. With debt settlement, you negotiate a lower lump-sum payment with the creditor, who then forgives the remaining balance. But the deal has to be a compromise, and that means the payment will be less than what is owed in full. At Delancey Street, our senior advisors work hard to settle for less than your original account balance, and we do not sell you another loan.
Speed is the other big difference. A consolidation loan is paid off over time, based on the loan terms and the interest rate. On the other hand, debt settlement aims to resolve your debts more quickly.
The trade-off shows up on your credit report. With a consolidation loan, your credit score will take a hit when you first apply for the loan. Opening the new account can push it lower. But then, as you pay it off, the score will start rising again. Settlement works the other way around. To gain leverage, you typically stop making payments for the duration of negotiations. This means your credit score will take a serious hit. Once you make your settlement payment, the account is reported as settled for less than the full amount, and you can start rebuilding. The hit is often harder up front, but in general, you can think of settlement as a faster way to get out of debt.
If a creditor has already sued you, a consolidation loan will not stop the legal process. Consolidation won’t give you breathing room. With settlement, it is often possible to negotiate with the creditor’s attorneys to pause legal action while a deal is reached. Only bankruptcy goes further. At the time of filing, every lawsuit and garnishment is immediately stopped by its automatic stay. Consolidation is not a legal remedy, and neither is settlement. We are not a law firm, so when litigation or bankruptcy is the right call, we refer owners to a vetted independent attorney.
Don’t confuse either one with a debt management plan, which is not the same as debt consolidation or debt settlement. A credit counseling agency will negotiate with your creditors on your behalf to lower interest rates and waive certain fees. You make one lump-sum payment to the agency each month, which then distributes the funds to your creditors. This should not be confused with getting a new loan through a lending institution. No new loan means no new interest rate.
Before you hire anyone, know that the warning signs are similar when considering consolidation or settlement. Watch for high upfront fees, unclear terms and conditions, aggressive marketing, a promise to solve your problem before signing up to work with them, and billing you for a service you haven’t completed.
So which one fits your business? Ask yourself: do you need to restructure your debt? Or do you need to reduce it? Consolidation doesn’t solve your debts; it just wraps them into a new loan. Debt consolidation is not forgiveness. And it is not free. But unlike consolidation, debt settlement reduces the amount that you owe. Talk to a Delancey Street advisor today to find the right path to solving your debt problems. The first consultation is free and confidential, and if a cheaper option exists, we will tell you on the first call.
