If you’ve made the decision to get control of your debt (and possibly get rid of it), congratulations! Taking an honest look at your debt obligations isn’t easy. Neither is it easy to develop an effective repayment plan.
Over the last several years, two types of companies have emerged – both aimed at helping consumers manage and eliminate debt. Many people assume that “debt consolidation” and “credit counseling” are essentially one and the same, but they offer very different services and may not be right for everyone.
Debt Consolidation
Debt consolidation is exactly what it sounds like. All of your outstanding credit accounts are consolidated into one loan and one monthly payment. With debt consolidation, you take out a new loan and use it to pay off your creditors. It’s something you can do on your own, or with the help of a reputable debt consolidation company.
The benefit of debt consolidation is that it allows you to wipe away all of your debt (except the one large loan) at once. It also simplifies your budget, as you only have one payment to make each month instead of several. In addition, the interest rate on a debt consolidation loan is usually much lower than the credit card rates you’re paying.
Your ability to pay your creditors in one lump sum is also a powerful negotiating tool. Creditors may agree to accept a lower pay-off (called a “negotiated settlement”) when they know you can send the full amount all at once.
However, debt consolidation only benefits people who have good credit scores and aren’t behind in their payments. If you have bad credit, you may be able to get a loan, but the interest rate could be just as high (or higher) than what you’re already paying, which defeats the purpose.
If you decide debt consolidation is right for you, consider cutting up your credit cards until the consolidation loan is paid off. Some people are tempted to continue using their credit cards after the balance has been paid but while they still owe on the debt consolidation loan. Consequently, they incur twice as much debt, which – again, defeats the purpose of debt consolidation.
Credit Counseling
Credit counseling is similar to debt consolidation in that it begins with a thorough examination of your current debt. In addition, a credit counselor will look at your entire financial picture – not just your debt, but your income and assets as well.
Rather than paying off all of your debt with one large loan, a credit counselor helps you develop a repayment plan on all of your outstanding accounts. This may include negotiating lower interest rates, or the elimination of late fees. Some credit counselors also offer you an option to make one monthly payment to them, which they disburse to your creditors.
Meeting with a good, reputable credit counselor can relieve a lot of stress, because you’ll finally have your debt under control. And the repayment plan can offer some much-needed “light at the end of the tunnel.”
One potential downfall of credit counseling is that, if you decide to use a repayment plan, you may be required to close your credit accounts, which could cause your credit score to drop significantly. If, however, your debt is unmanageable and you’re behind in your payments – or considering bankruptcy – your credit is taking a hit anyway. Your credit score may drop even lower after you close your accounts, but credit counseling may help you repair your credit faster than if you tried to manage your debt on your own.
Ultimately, you want to think long-term. A temporary dip in your credit score may be worthwhile if, in the long run, you end up in a much stronger financial position.
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