Consumer Credit Counseling vs Debt Reduction: Which is right for you?

For decades financial experts have been arguing about which is better, debt reduction or consumer credit counseling. Let’s delve into the pros and cons of debt relief, credit counseling and debt consolidation, as all have their place in the right situation.

When you have too much consumer debt, it’s easy to feel overwhelmed and constantly behind financially. How will you ever climb out from under thousands of dollars of debt with interest rates often above 20% in 2024? Two of your options to pay down and pay off debt are consumer credit counseling and debt settlement, but what are they and which is right for you? 

This article will explore two popular debt management solutions: consumer credit counseling vs debt settlement. We will compare their features, benefits, and drawbacks to help you decide the right choice for you.

Consumer Credit Counseling Overview

Credit counseling is a free option that nonprofit debt agencies offer to help people manage money, pay off debt, and create a monthly budget to deal with debt better. Credit counselors will go over your debt load and help you understand why things got so unbalanced that you could not afford payments or to pay more than the monthly minimum. 

They also will devise a payment plan that may reduce your monthly payment by lowering your debt. Most debts will be paid off in less than five years. You will life a less luxurious lifestyle while paying off your debt, but your credit counselor can combine all debts into one payment, which they will distribute to the companies you owe. 

Here are some big benefits of credit counseling: 

• They help you come up with a debt payment plan that results in a lower monthly payment and will eventually pay off your debt. Your credit counselor will first review your debts and income to see if an effective debt management plan is possible. If you have enough cash coming in for a plan to work, they will consolidate all of your debt into one monthly payment. 
• Counselors will contact your creditors who have to agree to the plan. If you make your payments, your credit rating isn’t affected. 
• Most plans involve credit card debt, but medical debt and department store debt also can be involved. 

However, credit counseling takes time; it may take three or five years to pay everything off. Also, the credit card company may change its mind and make you pay the full balance. You also are only allowed on most plans to have one credit card and only for an emergency. 

You also will have to accept a more austere lifestyle during the repayment plan because more income will go towards debt payments. 

Debt Settlement Overview

A debt settlement company claims to work with your creditors to get them to take less on your debts than you owe. Rather than making several minimum credit card payments monthly, your debts are combined and you pay the debt settlement company a monthly payment. The money is held in escrow and used to offer credit card companies less than you owe on your balances. If the credit card provider agrees to the settlement, the debt settlement firm gets a cut of the original debt amount. 

Debt settlement companies operate on the assumption that most credit card companies will accept less than what the consumer owes to settle the debt and get part of what they are owed. Some credit card providers will offer to accept less and some won’t. Some also will not work with debt settlement companies at all. 

A legitimate debt settlement company that is highly rated by the BBB can be a good bet, but there are steep costs. If you have $10,000 of credit card debt outstanding, expect to pay at least $1,000 or $2,000 in fees to the company to settle the debt. 

Debt settlement can help you to become debt free in a few years in most cases. After the debt has been settled, debt collectors and credit card companies no longer contact you. You also don’t need to worry about a debt collection lawsuit. 

Considerations of Debt Settlement

Here are some considerations of debt settlement to weigh before making a decision: 

• They charge high fees and results aren’t assured. Even if they do reduce and settle debt, you will need to pay fees and interest that can be thousands of dollars. 
• Settlement will lower your credit rating significantly, sometimes by 100 points or more. The hit is temporary, but it will be on your credit report for up to seven years. 
• The IRS treats the debt you didn’t have to pay as income, so you must pay taxes on it. 
• Debt settlement scams are widespread, taking advantage of desperate consumers behind on debt. You can avoid this issue by only working with an established, BBB-accredited debt settlement company. 
• Some or even all of your creditors could refuse to take less than you owe. 

Alternative Debt Management Options

Several other debt management options are available besides credit counseling and debt settlement. These options help individuals struggling with debt to regain control over their finances and work toward financial stability. Some of the alternatives include:

1. Debt consolidation: This involves combining multiple high-interest debts into a single, lower-interest loan. This can make it easier to manage monthly payments and save money on interest charges. Debt consolidation can be achieved through personal loans, balance transfer credit cards, or home equity loans.
2. Budgeting and expense tracking: Creating a budget and tracking expenses can help individuals identify areas where they can cut spending and allocate more funds toward debt repayment. This can be done using budgeting apps, spreadsheets, or pen and paper.
3. Negotiating with creditors: Contacting creditors directly to negotiate lower interest rates or more favorable repayment terms can sometimes reduce the debt burden. It is important to approach these negotiations with a clear plan and be honest about your financial situation.
4. Prioritizing debts: By focusing on paying off high-interest debt first (also known as the “avalanche method”) or targeting the smallest debt first to build momentum (the “snowball method”), individuals can make more significant progress in reducing their overall debt.
5. Credit card balance transfers: Transferring high-interest credit card balances to a card with a lower interest rate or a 0% introductory APR offer can provide temporary relief and help save on interest charges. Paying off the balance before the promotional period ends is crucial, as interest rates may increase significantly afterward.
6. Seeking help from friends and family: Borrowing money from friends or family members can be an option for some individuals. However, this should be approached cautiously, as it can strain relationships if not handled responsibly.
7. Bankruptcy: As a last resort, individuals can consider filing for bankruptcy. This option should be carefully evaluated, as it has long-lasting consequences on one’s credit score and financial reputation. There are two main types of personal bankruptcy: Chapter 7 (liquidation) and Chapter 13 (reorganization). Consulting with a bankruptcy attorney can help determine if this is the right choice.

Each of these debt management options has its own advantages and drawbacks, so it’s essential to carefully evaluate one’s financial situation and goals before deciding on the best course of action.

Consumer Credit counseling vs Debt Settlement

Debt settlement can be a great option if the company is able to reduce what you owe significantly, but their services cost thousands of dollars. You also need to be certain the company is legitimate and not scamming you. Credit counseling is free and still can result in being debt free within a few years. But both plans take time for you to become debt free, so carefully consider your options before committing.

Are you interested speaking with a professional about Debt Settlement? Contact us today to get connected!

How a Debt Settlement Program Might Impact Your Credit Scores

Enrolling in a debt settlement program commonly leads to the accounts being marked as “settled for less than originally agreed.” This designation is viewed negatively because it signifies that you did not fulfill the entire owed amount to the lender. Consequently, accounts reported as settled receive negative scores from all credit scoring models.

If an account had no previous late payments before settling, it will stay on your credit report for seven years from the settlement date.

In certain instances, a debt settlement company might suggest allowing current accounts to become delinquent to facilitate negotiations with your lenders. Any tardy payments on an account will persist on your credit report for seven years, adversely affecting your credit scores.

Exercise caution with organizations urging you to join debt settlement programs, charging substantial upfront fees, or promising to remove accurate yet negative information from your credit report. According to the Federal Trade Commission, legally, negative information cannot be removed from your credit report before the specified time frames mandated by law, even if it is accurate.

Furthermore, the Credit Repair Organizations Act (CROA) outlines prerequisites for credit repair organizations before accepting any payment. Ensure you comprehend your rights and legal safeguards before committing to credit repair payments.

Credit Counseling Services and Their Impact on Credit Scores

Alongside providing budgeting, saving, and credit management guidance, many credit counseling services can establish debt management plans (DMPs). These plans involve negotiating repayment terms with your creditors. Under a DMP, you make a single monthly payment to the credit counselor, who then disburses the funds to your creditors. The debt may not be reported as settled for less than originally owed, depending on the plan.

Typically, these modifications do not have negative repercussions on your credit history, provided you adhere to the agreed-upon payment terms of the DMP.

Respected credit counselors, such as those affiliated with the National Foundation for Credit Counseling, often mandate your participation in credit counseling and education programs before or as a prerequisite for entering a debt management plan. They are committed to assisting you in addressing current debt challenges and preventing recurrence of similar mistakes.

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