Debt Settlement, Debt Management, Debt Consolidation: Which is Better?

If you're dogged by debt, there are a number of solutions out there, and they all sound kind of alike -- debt settlement, debt management and debt consolidation.

It can be dangerous to confuse them.

Debt settlement means paying less than you owe and getting creditors to accept it. Debt management is making one payment to a service that then divides it between your creditors. And debt consolidation means replacing several loans with a single one at a lower interest rate and / or payment.

Debt Settlement: Buyer Beware!

You don't have to go looking for debt settlement companies -- they'll come looking for you. They call you all day and catch you at dinnertime. Their pitch is this: You stop making payments to your creditors and instead put that money in an account (or worse, send it to the settlement company). The idea is to save up some money while at the same time soften up the creditor by not paying. Then, the debt settlement folks step in and offer to give the creditor about half of what you owe in one lump sum in exchange for the company forgive any amount that exceeds that lump sum.

If Debt Settlement Works

Even if it goes well, this might not be a great deal for you. First, the debt settlement company takes a very high fee -- 18 to 30 percent of the initial debt according to the industry’s lobbying group, the American Fair Credit Council. It takes two to four years to complete the process, and you'll owe income taxes on the amounts forgiven. So let's say you owe $40,000 and the settlement company convinces your creditors to settle your balances for half of what's owed for a 25 percent fee, and you're in a 25 percent tax bracket.

Initial Balance: $40,000
After Settlement: $20,000
Fee to Debt Settlement Company: $10,000
Taxes Due on Forgiven Debt: $5,000

Benefit to You: $5,000

And for that $5,000 you're going to be hounded by creditors for two-to-four years, trashing your credit, and risking a lawsuit or a rip-off. characterizes debt settlement as "extremely risky" and says that unless you can get at least two thirds of your debt forgiven, it probably doesn't make financial sense. The group claims that Chapter 7 bankruptcy is much less costly and more effective if you truly can't afford to repay your debts.

If Debt Settlement Doesn't Work

Even worse, if debt settlement doesn't work, you're risking a few things. First, many folks have turned over money to debt settlement companies and had it disappear. This includes an upfront fee (which you should NEVER agree to pay, unless it's a retainer for an attorney) and the money for the eventual settlement (which you should also never pay -- there is no reason you shouldn't hold this money yourself until it's needed).

Further more, there is no guaranty that your creditors won't simply get sick of you not paying your bill and take you to court -- and they'll probably be awarded what you owe PLUS interest PLUS the fees for collecting the money.

Debt Management

Then there are debt management and debt consolidation. Debt management is generally tied to credit counseling. The counselor helps you create a budget, comes up with a monthly payment you can afford, and works with creditors to get them to accept a manageable payment from you. Many time, the counselor will also get creditors to lower the interest rate and forgive late charges. These plans usually take about five years to complete.

Make sure you're working with a reputable outfit -- non-profits are usually (but not always) your best bet. Before you pay any money into your debt management plan (DMP), verify with your creditors that they have accepted such an arrangement. There have been instances of con artist (or just inefficient) counselors taking consumer's checks every month and not paying their bills. After you make that first payment, wait ten days or so and verify with your creditors that they were paid.

Chapter 13 bankruptcy is a court-ordered debt management plan that requires you to make payments to the trustee, who divvies it amongst your creditors. When your plan is complete, usually in five years, any unpaid balance is forgiven (and untaxed).

Debt Consolidation: DIY Debt Reduction

Finally, there's debt consolidation. Consolidating debt doesn't reduce your debt at all. It replaces one or more debt with another. It can work as a debt reduction strategy, though, if you follow through. For example, if you have a slew of accounts with a 17 percent interest rate and payments totaling almost $1,000 a month, you might be able to pay them off with a home equity or personal loan at a lower interest rate. You could get yourself a much lower payment and some breathing room each month -- repaying your debt over ten years at the lower rate would get you a much lower payment without increasing your total costs. Or you could keep making a higher payment, get debt-free faster and pay a lot less in interest. Check it out:


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Debt consolidation gets you out from under your debt without ruining your credit or risking a lawsuit. Debt management may be able to accomplish the same thing. Either choice is almost certainly a smarter tactic than debt settlement.

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