What is the difference between Credit Consolidation and Credit Settlement?

What is Credit Consolidation?

Well, simply put, to consolidate is to condense from large to small.  Let’s say you have various loan and credit card debt.  Instead of dealing with all of those separate bills and high interest rates, you would take out one large loan that would pay everything else off.  Then you would be left with one monthly payment, and hopefully a lower interest rate.

There are two types of loans that you can use when consolidating debt: secured and unsecured.  A secured loan is a loan that has some sort of collateral or asset to back it up.  In many cases people will use their house and get a home equity loan.  An unsecured loan is exactly like it sounds, the opposite of secured (a 0% APR credit card or personal loan would be a good example).  If you have no assets and decide to go for an unsecured loan, in many cases you will still have a lower interest rate than most credit cards you currently have.  The best option, of course, is to go with a secured loan because your bank will consider it less of a risk and you will have a better chance at getting a low interest rate.  If you should default on a secured loan, the bank is able to repossess your collateral.

How will credit consolidation affect my financial health and credit score?

Although the idea of having one payment instead of twenty may be appealing, you have to take a close look at the possible disadvantages. 

More times than not, if a person is already in a great deal of financial trouble, with several credit cards maxed out, they will not qualify for the low interest rates that would make debt consolidation worth the while.  So then you are getting yourself into a large loan with a high interest rate and it might end up costing you more money in the long run.  It might be helpful for you to sit down with a credit counselor or crunch some numbers with a loan calculator.  Check out this helpful loan calculator at Bankrate.com.

As far as the affect on your credit score, debt consolidation is essentially paying off all of your outstanding debts.  So that is a good thing, right?  Well, any time you a creditor in full, it will positively affect your credit.  Of course, you should be monitoring your credit report on a regular basis so that you can address any concerns that may arise.  The only thing that might potentially harm you is the issue of credit history.  It might affect your score negatively if you pay off all of your debt and then close every account, especially if the accounts weren’t very old.  You might want to keep a couple of your longest accounts open to keep building your history.  Take a look at this sample FICA score chart to see how your credit score is calculated.

What is Credit Settlement?

Credit settlement differs from consolidation in one specific way.  In consolidation, you are not combining all of your debt into one lump sum, rather you keeping your existing loans and settling with the creditor on a specific amount.  Usually, the creditor and the borrower will reach an agreement on a reduced balance that will be considered payment in full.  Creditors are more likely to settle on a balance rather than be forced with a potential bankruptcy, where they might not acquire any money from their client. You will probably want to hire a lawyer, debt settlement company, or credit counselor to help you with this process.

How will credit settlement affect my financial health and credit score?

Much in the same way credit consolidation paints a rosy picture, you must carefully consider the possible affects of credit settlement.

If you have reached a settlement with a creditor, it can be a good situation as long as you are making prompt monthly payments.  However, if you get into trouble and cannot make your payments, you face racking up some huge fees and growing interest.  As far as your credit score, debt settlement won’t have much of an effect either way.  If you are at the point where your debt has been “charged off,” then your credit has already taken the hit and this will be a wise decision.