Comparing Debt Consolidation, Debt Management and Debt Settlement

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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…

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.

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  1. Andy says

    Yes, cancelled debt can be income. The article and the comments, however, omit any mention of the exceptions to having to pay taxes on cancelled debt. For example, being able to demonstrate insolvency allows you to avoid taxes on the forgiven/cancelled amount. Many folks who have to resort to settling debt can demonstrate insolvency. See 26 USC 108 and IRS Form 982.

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