Comparing Debt Consolidation, Debt Management and Debt Settlement

by Contributor

Surely you’ve seen at least a couple of ads for debt relief services as you’ve been watching television.

Some of the ads make promises that must sound pretty enticing to someone carrying an unmanageable debt load and struggling to get by. But not all debt relief services or personal circumstances are created equally.

For someone who truly needs some professional help to get out of debt, it is crucial that they understand the different types of debt relief services and the pros and cons of each.

Debt consolidation

This is simply a loan. You borrow enough money to pay off all of your other accounts. It’s basically trading debt for debt, but it can work. There are to key pieces to successfully using a consolidation loan to pay off your debt. The first is to make sure you get a good interest rate that is lower than your current interest rates. The second is self-discipline. Too often, people take out consolidation loans, but continue to use their credit cards. Ultimately they end up in double debt trouble.

Two common forms of debt consolidation include a Home Equity Line of Credit, a loan against the equity in your home, and a balance transfer credit card which transfers your credit card balance to a low interest rate, often as low as 0%.

Credit counseling

Credit counseling involves a meeting, either in-person or via phone, with a credit counselor who will review your financial situation and possibly offer you a debt repayment plan, referred to as a debt management plan, or DMP. A credit counseling session can help you get a better picture of your situation, and often there is no cost for the session. A DMP is one in which the credit counseling agency gets your creditors to lower your interest rates, so more of your monthly payment goes towards your principal balances. But, you are no longer allowed to use credit. The monthly fee is usually under $50.

A DMP may not be the right plan for you if your debt is so great that you cannot afford to make adequate monthly payments, or if you are not committed to living life without using credit. Also, your credit report may show that your accounts are handled by a credit counseling agency. However, at the end of the program that notation drops off, and your accounts will be shown as “paid in full.”

Debt settlement / negotiation

These are probably the ads you see most often. If you choose to use a debt settlement company, representatives will tell you to stop paying your creditors and make a monthly payment to the settlement company. Once you’ve saved up a lump sum of money, the settlement company will attempt to negotiate with your creditors to accept a lesser payoff amount.

Settlement companies typically charge an upfront fee of 10 to 15 percent of your total debt, even if they cannot successfully negotiate your debt. Some companies require their clients to sign over power of attorney. You run the risk of being sued by your creditors since you’ve completely stopped paying them. If your creditor forgives more than $600 of your debt, you will be required to pay income tax on the forgiven amount. Also, your credit report will reflect that you settled the account for less than you owed, which is a red flag to future lenders.

If you do choose to go the settlement route, you can handle the negotiations on your own without paying a company exorbitant fees. Just make sure you get any agreement with your creditors in writing and make sure you understand the implications to your credit report, credit score, and taxes.

Examine your needs and choose wisely

Take some time to look at your financial situation, your circumstances, and the pros and cons of all available options.You can probably create your own debt consolidation plan, but the other options require you to work with another company and your creditors. Ultimately, it’s up to you to decide which method is the best to pay off your debt.

Kristen Doerschner is the public relations coordinator for a non-profit debt relief agency and a freelance writer. Through her writing, Kristen covers a variety of topics, but specializes in issues related to financial education.

Published or updated February 10, 2010.
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{ 7 comments… read them below or add one }

1 fredct

Great post, thanks for the clarification as the terms often get tossed around without definition.

However, I have one not-so-small nitpick:
“If your creditor forgives more than $600 of your debt, you will be required to pay income tax on the forgiven amount.”

Not true. $600 may be the threshold for the creditor to file a 1099-MISC, but if they forgive you 1 cent of debt (or, technically, 50 cents, since tax forms usually round to the dollar) you still must legally recognize it as income.

Don’t mistake 1099 filing thresholds with reporting thresholds. For instance, a 1099-INT must be filed if a bank pays you over $10, but you’re still required to include it on your taxes if a bank pays you $5, or $1 or 50 cents, even if they don’t send you a 1099.


2 Kristen

Thanks for the clarification. I’m definitely going to do more research on this. I have tons of information about the $600 threshold, yet nowhere that I’ve found talks about having to declare less than $600 as income.

It should also be noted that if the forgiven debt is $600 or more and a person doesn’t get a 1099 form, that doesn’t mean they don’t owe the taxes. No form does not equal no taxes.


3 fredct

Well, it doesn’t talk about it more because it doesn’t say not to. I’ll explain, but first, one quick correction of mine… I believe canceled debt is reported on a 1099-C, not -MISC.

Anyway, here’s the quote from IRS Publication 17 (your source for everything personal income tax related), under the “Canceled Debt” section:
“Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold.”

Note that it says nothing about being below a certain amount. It *does* say: “Form 1099-C. If a Federal Government agency, financial institution, or credit union cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2.”

But we should not conflate the difference between receiving a 1099 for something, and being required to report it. You are required to report everything truthfully and fully, whether you got a 1099 or not.

This is also stated in Publication 17:
“Interest not reported on Form 1099-INT. Even if you do not receive Form 1099-INT, you must still report all of your taxable interest income. For example, you may receive distributive shares of interest from partnerships or S corporations. This interest is reported to you on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S).”

“Dividends not reported on Form 1099-DIV. Even if you do not receive Form 1099-DIV, you must still report all of your taxable dividend income. For example, you may receive distributive shares of dividends from partnerships or S corporations. These dividends are reported to you on Schedule K-1 (Form 1065) and Schedule K-1 (Form 1120S).”

I can’t find a general rule, but really the main point is that if there’s nothing saying you don’t have to report it, so you do. Here’s some more sources:
(the taxalamanac one gets into some details on where to report it, but not really if)


4 fredct

One more for fun:
“Franklin Templeton is not required to report distributions less than $10 unless backup withholding was withheld. Although the IRS does not require Franklin Templeton to report distributions less than $10, the IRS requires you to report such distributions on your income tax return. Although Form 1099-DIV may not be mailed to you, distributions less than $10 can be found on your Year-End Asset Summary Statement.”