Debt Consolidation vs Debt Counseling

If your debt has gotten out of control, you may need help getting it sorted out again. There are two primary options for reorganizing and paying down old debts, but despite their similar names, they are not the same thing. If you feel like you are drowning in debt and payments, there is help available. You just need to decide which type you need – credit consolidation or credit counseling.

What is Debt Consolidation?

At the highest level, debt consolidation is getting a single loan to cover all the debts you have and then making one payment instead of many every month. The idea is that if you have five smaller loans totaling $25,000 in debt, you are likely making five separate payments on those loans. Those five monthly payments might add up to over $600 per month.

A single personal loan for $25,000, on the other hand, might come with a set payment of $450 per month. Also, a personal loan will have a set number of payments, unlike credit cards, so that you can be completely free of the debt in two, three, or four years.

Steps for Debt Consolidation

To get started with debt consolidation, you will need to follow a few important steps so that the process is successful.

Step 1 – Tally up your debts.

If you don’t know how much you actually have in debt, you can’t pay it off with a single consolidation plan. This can be a hard step if you haven’t actually seen how much debt you have. Find every loan, every credit card, every bill that comes from borrowing money or credit and add up the total balance and the monthly payment.

Don’t be surprised if the number is far higher than you imagined. Credit can add up quickly.

Step 2 – Identify the most problematic debts.
Not every debt is a bad debt. A mortgage isn’t in the same category as a credit card. Your mortgage and your car payment can likely be removed from the debt total as these are secured loans and likely have a more reasonable interest rate than credit cards. Once you remove the large, secured debts, check your totals again – how much credit card debt do you have?

Step 3 – Seek out loans
If you have $20,000 in credit card debt with a combined monthly payment of $600, your goal is to find a loan that will cover that $20,000 with a payment of less than $600 per month. Even if the consolidation loan winds up about $600 per month, you’ll have set terms for the loan and can count on being debt free after three, four, or five years.

You can arrange a debt consolidation loan in several place. These are almost always going to be personal loans, but you might also have other options. You can find funds as a personal loan for consolidation through:

Online lenders
Traditional banks
Credit unions
Peer lenders

You can also borrow what amounts to your own money and use it for debt consolidation by considering:

A loan from your 401k or retirement account
Home equity loans

Just be aware that these loans have additional risks. If you fail to repay your home equity loan, the bank might take your home as payment.

Step 4 – Pay off your cards.

Once you have the debt proceeds, use them to pay off the complete balance on your credit cards. Once you’ve paid off the balance, cut the cards up or put them away where you won’t be tempted to use them. Focus on repaying the consolidation loan and enjoy being debt free as soon as it’s paid off.

What is Debt Counseling?

Debt counseling has two variations – credit counseling and debt settlement. These two may be approached in the same package if you work with some companies, other times they are offered as separate services.

Understanding Credit Counseling

Credit counseling is an education program. It teaches you about debt and finances and helps you figure out how to set a budget, make timely payments and get your financial house in order. There is usually no cost associated with credit counseling because it’s offered as a goodwill service through non-profit companies and service organizations.

If your finances are a mess of paperwork, a credit counselor can help you sort through the bills, make a plan for repayment, and will generally be your ally as you regain control of your bills. There is no money involved and no new loans. It is support and information only.

Understanding Debt Settlement

Debt settlement is different than counseling, although one company may offer both. Debt settlement is a service you pay for. Companies offering debt settlement will reach out to your lenders on your behalf. They will negotiate a repayment amount for each of your debts that is lower than the total balance. Basically, they will tell a credit card company that you can’t repay the total amount and the credit card lender asks for you to pay 60% of the total balance instead.

Once the settlement company has arranged deals to pay off debt with all of your lenders, you send funds to the company every month. The company then sends the funds to the lenders on your behalf. While it feels good to offload the debt problem onto a company working on your behalf, debt settlement comes with steep risks. In some cases the settlement company is not ethical and will keep funds rather than using them for repayment. In every case of debt settlement, you can expect significant damage to your credit score. The resettlement, and any late payments sent on your behalf, hit your credit score and can cause significant harm that lasts for years.

Credit counseling is a wonderful service to help you learn about money and finances if it comes without any obligations for debt settlement. Debt settlement, on the other hand, can be dangerous and may not be the answer you were looking for.