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What's the Difference Between Debt Consolidation and Debt Settlement?

Put simply, debt is borrowing money that has to be paid back later. It is a financial obligation toward a lender or creditor and is for fulfilling a financial need that otherwise cannot be met with one’s own money. Funds are borrowed for various personal and/or business reasons. In common parlance, debt can be referred to as secured or unsecured loans. Secured loans are given in lieu of collateral and generally have lower interest rates than unsecured loans. For example, gold loans are given against gold ornaments as collateral. Unsecured loans are ones in which no security is taken and command a higher rate of interest than secured loans.

Loans can also be categorized as structured or unstructured. An unstructured loan is usually borrowing from friends and family where the repayment terms are not categorically laid down. A structured loan is one in which the repayment terms, EMI, interest rate, etc are categorically documented. If a borrower is unable to repay the loan for any reason, the debt keeps piling and could put the borrower in a debt trap. Debt settlement and debt consolidation are two options for getting out of a challenging situation.

What are Debt Settlement and Debt Consolidation?

In simple language, Debt Settlement reduces the amount of debt and Debt Consolidation reduces the number of creditors. Both are financial strategies to reduce the debt load of a borrower. Let us understand both of these terms in detail.

Debt Settlement: Debt settlement is when you negotiate with a creditor to settle your debt, often for less than what you owe. In many cases such as credit card settlement, this option could be offered by the lender too to get back at least some amount that it is owed. Once the creditor and borrower accept this route, the borrower has to make a lump sum payment to settle the debt. It negatively impacts your credit score and that can make finding future financing difficult. Ideally, debt settlement should be your last option after you have exhausted all other avenues to repay the loan. It should be noted that creditors are under no obligation to accept your debt settlement offer.

Advantages and Disadvantages of Debt Settlement

The main objective of a loan settlement is to reduce your debt load by paying less than you owe the creditor.

PROS CONS
If the settlement offer is accepted, you will have to pay less than you owe. Creditor might not accept the offer of loan settlement.
Debt gets paid off sooner There might be extra settlement charges and fees.
You can potentially avoid legal action from lenders. Your credit score takes a hit and it could take a long time to rebuild it.

Debt Consolidation: It is a form of debt relief and it combines multiple debts into a single new consolidated debt. It helps to reduce the number of creditors you owe money to. A debt consolidation loan may be either secured or unsecured.

Advantages and Disadvantages of Debt Consolidation

PROS CONS
Simplifies the debt repayment process by reducing the number of loan accounts to manage. Changes only the structure of repayment and the borrower still has to repay the loan in full.
You could get a better interest rate on your new loan owing to market conditions and/or a better credit score. The terms and conditions of the new debt consolidation loan could depend on your credit score. A bad score could negatively impact the new interest rate and other terms.
A longer tenure debt consolidation loan could help you better manage your monthly expenditure and EMIs. There could be additional charges and fees on the new loan.

Key Differences between Debt Settlement and Debt Consolidation

  Debt Settlement Debt Consolidation
Working Structure Aims to lower the total amount of debt you owe by paying a full and final amount less than the total amount due. Aims to reduce the total number of creditors that you have to pay by combining the debts into a single new loan.
Credit Score Your credit score might be slightly impacted. Your credit Score takes a big hit.
Repayment It helps to pay off your debts faster. A new debt consolidation loan will have the repayment tenure of a normal loan.
Process Eliminates the debt entirely, provided the settlement offer is accepted by the lender. Doesn’t eliminate the original debt, simply reorganizes it.

Conclusion

Being in debt is stressful and can impact many aspects of our lives. Debt consolidation and debt settlement are both forms of debt relief that may help you manage your debt, albeit in very different ways. Both have their challenges and benefits and you should choose the one that is most aligned with your objective.

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