When you’ve taken on more debt than you can pay and the interest charges continue to mount, it may be time to seek help.
Credit counseling and debt settlement are two solutions that can offer you assistance in paying off the debt you owe, whether in the form of maxing out credit cards or paying off loans you can’t afford.
But credit counseling and debt settlement differ in important ways. Here’s what you need to know about the cost, process, and possible long-term effects of each so you can make the right decision to pay off your debt.
Credit counseling organizations and debt settlement companies have different approaches to helping you resolve your debts with lenders and creditors.
When you work with a nonprofit credit counseling organization, you will typically have a meeting to discuss your financial situation so the counselor can determine if a debt management plan is right for you. If you opt for a debt management plan, the counselor works with your lenders on different options for paying off your debt, which may include lower interest rates, a lower monthly payment, or a longer repayment period. Credit counseling generally does not reduce the amount of debt you owe, but it can make repayment easier by making your monthly payment more affordable.
Debt settlement companies, on the other hand, can reduce your debt balances through negotiations with your creditors. Those negotiations may lead to settlements, which may include a lower reimbursement amount.
It is important to know that many lenders and creditors do not work with debt settlement companies and there is no guarantee that the company will be able to successfully reduce your debt. In fact, these companies often can’t get better terms for your debt than you could negotiate yourself, according to the Consumer Financial Protection Bureau (CFPB).
Here are more details on how each process works:
The fees you will pay for credit counseling and debt settlement will vary, but credit counseling is usually much cheaper.
For credit counseling, your first session with a counselor is usually free. The organization may also offer free financial education materials and tools.
But you should expect some fees when you enroll in a debt management plan through credit counseling. For example, you may pay a one-time fee to start and then a flat monthly fee, although you may also qualify for fee waivers depending on your income and other factors.
For debt settlement, you will typically pay a percentage rather than a flat fee. The company can request a portion of the total debt that the company resolves or a portion of the money that the company avoids paying.
However, be wary of any debt settlement company that asks for upfront payment. According to the CFPB, each of the following things must happen before a debt settlement company will ask you for payment:
-
The company reaches an agreement or successfully negotiates with its creditor.
-
You agree to the terms with the creditor.
-
Make at least one payment to your creditor or lender under the new terms negotiated by the debt settlement company.
When you adopt a debt management plan with a credit counseling service, you will make a monthly payment to the credit counselor and they will transfer the payment due to each of your creditors. This can help you consolidate your debt into a single monthly payment that’s easier to track.
With debt settlement, you may be encouraged to stop making payments to your lenders during the negotiation period. Instead, you will typically contribute payments to a dedicated bank account. This account must be at a separate institution from the debt settlement company and can be accessed at any time.
Once the company reaches an agreement with its creditor or lender, they will use the money in that account to pay off its debt in a lump sum. If the debt settlement company does not negotiate an agreement with your lender, you will still be responsible for paying late fees and interest accrued during that period.
If you have outstanding debt, it may already be affecting your credit. You can increase your credit utilization when you spend close to your credit limit or max out your credit cards, and late payments may be reported to the credit bureaus and appear on your credit report. If your debts go into collections, it will also have a negative effect on your credit.
Whether you choose credit consolidation or debt settlement, you may also see some credit impact.
Because credit counseling often requires you to close your credit card accounts, your credit could be temporarily affected. But as you make payments on your debt, build a positive payment history, and reduce your credit utilization (because you won’t be using your cards or opening up more credit), you can rebuild your score.
With debt settlement, the biggest risk is that the debt settlement company will not be able to reach an agreement with your creditors. During the negotiation process, you may be asked to stop making monthly payments. If there is no agreement later, those late payments can accumulate and result in negative information on your credit report, as well as a significant amount of late fees and penalties. Late payments and collections can remain on your credit report for seven years.
There are scammers posing as credit counseling organizations and debt settlement companies. Bad actors often make false promises about paying off your debt and ask you for money up front.
If you opt for credit counseling, be sure to choose a reputable nonprofit organization. Two sites you can use to find credit counselors include the National Foundation for Credit Counseling (NFCC) and the Financial Counseling Association of America (FCAA).
Always do your research on any debt settlement company before agreeing to work with them, and be on the lookout for common red flags that a company may be scamming you, such as upfront fees, a guarantee to settle all of your debts, a promise that you can avoid debt collections or lawsuits, and more.
Read more: Are debt relief companies legitimate?
Both credit counseling and debt settlement require a long-term commitment to paying off your debt. A debt management plan or a debt settlement negotiation can take years and both require you to make consistent payments on the balances you owe.
Credit counseling is a great starting point that can help you pay off your debt with lower fees and less potential impact on your credit score. If you don’t qualify for a balance transfer credit card or debt consolidation loan, this is a good option to get help paying off your debt. One of the biggest benefits of a debt management plan from a credit counseling service is getting more manageable monthly payments that can help you reduce your overall debt over time.
When you opt for credit counseling, make sure you are okay with closing your credit card accounts. You may also not be able to open new accounts for a certain period under a debt management plan.
Debt settlement can be much riskier for your credit score and your wallet. If your creditors refuse to negotiate a settlement, you could be left with a negative impact on your long-term credit score and even more debt (more fees and penalties) than you started with.
If you choose to work with a debt settlement company, make sure you are informed exactly how much you will owe and when. Be prepared for the possibility that you may not be able to pay off all of your debt, even if the company is able to successfully pay off some of it.
An alternative to working with a third-party debt settlement company (and one you may want to consider doing first) is to contact your creditors yourself. You may be able to negotiate a payment plan, fee waiver, or even reduced payments without having to pay a debt settlement company’s fees.