When you’re trying to manage debt in multiple places, you may be tempted by debt consolidation. But you may be wondering about the details of this decision, including whether the amount you actually owe changes. And it might not be clear how consolidation differs from debt settlement.
Fortunately, if you’ve been wanting a clearer understanding of debt consolidation, you’ve come to the right place. Stay with us as we unpack this process so you know what the repercussions are if you default or use co-signers.
Defining Debt Consolidation
With debt consolidation, you’ll combine existing debts into one monthly payment. This means you’ll have a single new loan, often with a better interest rate. Legally, you’ll be free from indebtedness to the old accounts you previously paid.
Instead, you’ll owe money to a new lender. It’s important to be clear on the terms of your new loan, including the interest rate and repayment policies. Ultimately, you’ll still need to repay your debt, but the process to do so is simpler.
Comparing Debt Consolidation and Debt Settlement
With debt consolidation, it’s critical to understand that your debts will remain. You’ll still be legally liable, though you may see lower monthly payments thanks to a lower interest rate.
It’s also important to know that consolidation is distinct from debt settlement. With consolidation, you’re still paying back your existing debts through one payment. But with a debt settlement, the goal is to lower the amount you owe through mediation efforts with creditors.
Creditors need to be willing to settle for less than the full balance for a settlement to happen. In some cases, like difficult medical situations or long stretches of unemployment, the creditors may forgive the remaining balance of a debt.
While debt settlement may sound more appealing because some debt goes away, it does have its downsides. Your credit score will take a hit, and you could encounter more complex tax situations.
With consolidation, you’ll just be working with a new payment plan to repay your full debt balance. Consequently, credit score or tax issues won’t affect you.
Evaluating Debt Options
As you’re trying to choose the right financial move for managing debt, you’ll want to have a clear picture of your finances. Your liabilities refer to your obligations to pay back debts. Your expenses include your monthly utility payments and rent, among other recurring costs.
With debt consolidation, you can see lower expenses since the interest rate will be lower. But your liabilities remain the same.
But with a debt settlement, your liabilities will change since the amount you legally owe will go down. Visit Empower | The Currency to learn more about financial liabilities and how they can impact your situation.
Understanding the Repercussions of Defaulting
If you opt for debt consolidation, you’ll want to be aware of what happens if you default. The new lender could report the late payments to credit bureaus, or you could hear from collections. Both of these situations can end up causing harm to your credit score.
In some instances, a lender may file a lawsuit. While you won’t be liable for old debts that have been paid, you will be stuck facing the repercussions for your new loan balance.
With debt settlement programs, defaulting also presents challenges. You won’t be paying creditors during the debt negotiation process, but you will need to pay the amount agreed upon through the settlement. You could face fees, loss of terms, or legal action.
Being Mindful of Other Key Implications
When you go through debt settlement, know that you may receive a 1099-C form. This can happen in scenarios where $600 or more is forgiven. And that amount of money can be considered taxable income, meaning you’ll need to pay more at tax time.
By contrast, debt consolidation does not result in a 1099-C being issued. That’s because no debt is being forgiven.
Additionally, you’ll want to be aware of obligations if you use a co-signer to help manage your debt. With debt settlement, a co-signer still will be implicated in the new terms of your agreement if their name is attached.
With a consolidation, co-signers can be released from liability if their name is not on the new loan. This release needs to be in writing. But if a friend or family member decides to co-sign on the new loan, they will be liable.
Looking into Debt Consolidation
Debt consolidation won’t alter how much you legally owe. But it can simplify the payment process so you can chip away at paying off your debts more easily. Be aware of how consolidation differs from debt settlement, and know the consequences of defaulting.
When you understand the details of your options, you can make the best choice to handle your debts.
