The financial crisis of 2007-2009 saw many people lose their homes, jobs, and businesses, and subsequently plunged neck-deep in debt leading some into bankruptcy. One of the biggest sources of personal debt implosion is from credit cards.
Credit cards have become part and parcel of daily life. But credit card debt can be a source of overwhelming stress and sleepless nights thanks to the constant phone calls from credit card companies.
When one holds more than one credit card and finds themselves in card debt, there are two options that they can consider – settling the debt with on each card or consolidating the debt from different cards into one card or one loan.
Each solution has the circumstances where it is most appropriate and it is thus important that one understands the strengths and vulnerabilities of each before settling on either one.
Before embarking on an analysis of the two, one must be clear on the exact amount of debt they owe. It is not surprising to find that many people struggling with credit card debt are uncertain of and thus unknowingly understate the amount of debt they actually owe. So if you are in card debt, you must first examine all your card statements.
Request the credit card company for a statement of all your cards. This will help you identify by how much you may have maxed out your credit card limit, how late your payments were and what are the over the limit and the lateness fees respectively. Checking the accuracy of these amounts will allow you to better weigh your consolidation versus settlement decision.
What each involves:
Credit card debt settlement
Persons that do not have a regular income or are experiencing reduced income and hence cannot keep up with the monthly payments may opt for credit card debt settlement.
To initiate debt settlement talks, you may be required to deposit or accumulate a certain amount of money in a trust account that you will use to negotiate a reduction of your outstanding debt with the credit card company.
Credit card debt consolidation
This is where one applies for a loan and then uses the proceeds to pay off all their credit card debts leaving them with only one debt to service. Consolidation can also involve using one credit card to pay off the other cards thus leaving you with only one credit card to service.
This process is fairly straightforward as long as you meet all the requirements. To qualify for a debt consolidation loan, you should either own your own house, have adequate equity on your mortgage to use as collateral, have a low FICO score and also have a steady source of income. Ideally, one should for a loan that is at a lower interest rate than their existing debt.
Advantages of debt settlement
Of the two (settlement and consolidation), it is an only settlement that results in a reduction of the debt owed. The reduction can be as high as 50% of the original debt – a drastic drop by any measure.
Since with some types of bankruptcy, credit card companies may not get any payments on the debt, the card companies would prefer to avoid their client filing for bankruptcy, They would rather have you settle part of the debt and receive less than what was the total outstanding amount instead of receiving nothing at all.
Disadvantages of debt settlement
Settling debts translates to bad loans and hence losses in the books of credit card companies. The card company thus considers the settlement the last resort thus making the process stressful and tiresome.
You will need to engage a lawyer as well as a debt settlement agent both of whom will cost you in terms of professional and service fees. The negotiation period for settlement is long and can go on for years.
Settlement companies will often advise you to stop any payments to creditors during the negotiation. The creditors will continue to report this to the credit bureaus thus worsening your credit ratings and ultimately making it difficult for you to secure credit in the future.
Advantages of debt consolidation
Debt consolidation is a more private process than debt settlement. You can negotiate directly or use debt consolidation agencies to merge many credit card debt repayments into a single monthly payment.
Since creditors will still eventually receive their principal amount, the only thing that changes are the terms of payment. Therefore, credit card companies will be more willing to come to an agreement as compared to settlement.
The goal of consolidation is a convenience in repayment. With consolidation, you will still pay the total amount owed but through easier monthly payments to creditors.
Furthermore, the interest rates on your debt can also be reduced thus helping you pay off your debt much quicker. Unlike debt settlement, your credit rating will not be ruined by debt consolidation. You have not defaulted on the card debt but have simply transferred it to a single loan.
Disadvantages of debt consolidation
The consolidation process requires one to have collateral in order to secure the loan. For those with no acceptable collateral, then debt consolidation is not an option. But using the house as collateral is of itself a risk – you run the risk of losing the house it in case you default on the loan.
In addition, despite the possibility of saving on the debt amount through a reduced interest rate, the saved amount is usually tax-deductible which reduces your overall savings.
Before settling on either option, one must undertake a thorough cost-benefit analysis to determine which option is most practical and in your best interest.