Has your debt reached a point where it’s virtually impossible to stay financially solvent while still staying up to date with your minimum payments? Despite how desperate the situation feels, there are options that will help you get your head above water.
However, these options for handling your debt come with different requirements and can have vastly different impacts on your overall financial picture. The key is knowing what will work for your current situation and what will leave you in the best financial standing going forward.
Debt Settlement vs Debt Management (Which is Right for You?)
Here is a breakdown of two debt relief options you might be considering: debt settlement and debt management.
What is Debt Settlement?
Debt settlement is an agreement made with a creditor that reduces the total amount due on your debt. This agreement is usually facilitated by a third-party debt settlement firm which will first instruct you to stop paying on your debt for a period of time (3-6 months, on average). Once the account has entered delinquency, the idea is that you will have bargaining power with the creditor and the total due could be reduced significantly.
Cons of Debt Settlement:
- Debt settlement can wreak havoc on your credit score. Payment history makes up 35 percent of your total credit score, so if you are stopping payment on several accounts (or even just one) in order to negotiate with your creditors, your overall score could be severely impacted.
- There are no guarantees with debt settlement. The hope with debt settlement is that creditors will be hungry enough for payment once your account has become delinquent, they will be eager to negotiate. However, there is no guarantee this will actually happen and you could be in an even worse financial situation afterward.
- You’ll still be required to pay taxes on any settled amount over $600. If you luck out and the creditor agrees to accept a much smaller payment amount, the difference is seen as taxable income by the IRS and you’ll have to pay come tax time.
Pros of Debt Settlement:
- You could have a quicker, less expensive path to debt freedom. The one upside to debt settlement – paying less to creditors than was originally owed – can help pave a quicker path to getting out of debt. However, even this should be taken with a grain of salt. Not everyone has this experience, and taxes and fees should be taken into consideration before going this route.
What is Debt Management?
Debt management is a plan established by a credit counseling service or debt management firm to help you pay your creditors off in full. This might involve working to lower interest rates and fees in order to make the debt more manageable. It also consolidates all monthly payments into one payment given to the debt management firm or credit counseling service, which is then distributed to each creditor.
Cons of Debt Management:
- Your credit score can suffer. One of the requirements of a debt management plan is to close open accounts in order to stop the slow bleed of debt buildup. Closing accounts reduces your available credit and can negatively impact your length of credit history.
- The cost of debt management can be high. While the cost of debt management varies, it could be as high as 15-20 percent of the total debt owed. If your debt is large, this could be an additional financial burden you just can’t bear.
Pros of Debt Management:
- Debt management helps organize debt. Instead of you having to keep track of all payments due and hoping you pay them on time every month, debt management reduces everything to one monthly payment. This can increase organization and reduce financial stress.
- You could lower fees and interest rates. Often times the third-party executing your debt management plan already has established relationships with your creditors, so they have a greater chance of lowering interest rates and reducing fees that make your debt unmanageable. This could, in turn, shorten your payoff time.
- Debt management helps address the underlying financial issues. While getting out of debt can release a heavy burden from your shoulders, it can be a lot of work for a very little benefit if you don’t address the underlying financial issues that caused the problem in the first place. Good debt management plans will include some type of credit counseling to address these issues.
Which is Right for You?
Before deciding between debt management and debt settlement, make sure you understand the associated costs, including taxes you will be responsible for after debt payoff. Your end choice should never add an additional financial burden you can’t handle.
In addition, understand how your credit score will be impacted and what this means for your financial picture moving forward.
Understanding each of these pros and cons will ensure you won’t be hit with any nasty surprises down the road.