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A debt consolidation program could help you save time and money, making it easier to manage your bills and pay off your debts. It depends, however, on the type of program you use and whether you're able to follow through with it.
With some programs, you'll receive personalized advice, and the organization will negotiate with creditors on your behalf. With others, you'll be left largely to your own devices. Either way, the end-goal is the same—get out of debt—but you'll want to understand how each program works before you start.
What Is a Debt Consolidation Program?
Organizations may offer different services they describe as debt consolidation programs. As a result, there isn't a single definition, but programs commonly include:
- Debt management plans (DMPs): Nonprofit credit counseling organizations offer DMPs to help borrowers take control of their unsecured debts, such as credit card debts. A counselor will review your credit report, bills and finances to offer you personalized advice and act as a mediator between you and your creditors. Once an agreement is reached, you'll send the credit counselor a monthly payment that will be disbursed to your creditors. Usually, it takes around three to five years to complete the plan.
- Debt consolidation loans: Many people consolidate their debts with a debt consolidation loans. Companies may help connect you with lenders and help you find the best offers, but it's largely a DIY program. Depending on your new loan's terms and rate, you may be able to lower your monthly payment and save money on interest.
- Debt settlement: Some debt settlement companies may advertise their service as a type of debt consolidation. A debt settlement program will ask you to stop paying your bills and instead send the program a monthly payment it will set aside in an escrow account. Once you're far behind on your bills, the company will use the money in the account to try to settle your outstanding debts for less than you owe. Beware, though, that payment history is the biggest factor in determining your credit score, so the process of missing payments to eventually try to settle the debt will likely hurt your credit score. In addition, these services often charge a hefty fee and, depending on how much debt was forgiven, you may have to pay taxes on it.
The requirements, process and impact on your credit can vary with each program, and there are benefits and drawbacks to each option.
How Is a DMP Different Than a Debt Consolidation Loan?
Unless you're already far behind on payments, a DMP or debt consolidation loan are the best option if you want to repay your debts while preserving your credit.
While debt settlement can result in repaying less money overall, stopping your payments can hurt your credit and lead to more fees and interests. After you acquire these additional expenses, there's no guarantee that a creditor will accept a settlement offer (it could even sue you instead). When creditors do settle, you may need to pay a portion of your savings to the debt settlement company.
Both DMPs and debt consolidation loans can help you pay off your debt while potentially saving you money. But they may only be options if you can afford to make monthly payments.
With a DMP, you won't be taking out a new loan. Instead, you'll send a monthly payment to the credit counseling organization, which acts as an intermediary between you and your creditors and manages the DMP. There may be a monthly fee for the DMP, although some counseling organizations may waive the fee depending on your income.
A debt consolidation loan is largely a DIY option that involves taking out a new loan to pay off your current loans. You can get help comparing loan offers, but you'll need good credit to qualify for a large loan with the best terms. Some lenders will send money directly to your current creditors. With others, it's up to you to use the money to pay off your debts.
Who Offers Debt Consolidation Programs?
Nonprofit credit counseling agencies such as the National Foundation for Credit Counseling offer DMPs, while debt settlement companies and debt settlement attorneys may offer debt settlement services. You have many options if you're interested in the debt consolidation loan route. For example, you could take out a personal loan, open a balance transfer credit card or use a home equity line of credit to consolidate your debts.
In every case, be wary of scams and promises that sound too good to be true. Fraudsters prey on borrowers who are desperate for help, and there have been many cases of individuals and companies taking debtors' money without offering any real service in return.
How a Debt Consolidation Program Can Affect Your Credit
The impact on your credit will depend on your overall credit profile and the type of debt consolidation program you use, but, in general, this is what you can expect from each strategy:
- Debt management plans (DMPs): A DMP doesn't have a direct impact on your credit, but the program may lead to an initial drop in your credit scores when you close your credit cards. However, your credit scores may increase as you continue to make on-time payments.
- Debt consolidation loans: Applying for a new loan and opening a new account might ding your scores a little. But overall, a debt consolidation loan could improve your credit scores as your credit utilization rate will decrease if you consolidate credit card debt with an installment loan.
- Debt settlement: The debt settlement route will often hurt your credit, as you're advised to stop paying your bills and let your accounts go past due. It could also take a long time to recover if your accounts go into default, are charged-off or sent to collections.
Protecting your credit is certainly important as your credit can impact many aspects of your life. With this in mind, a DMP or debt consolidation loan could be best for your credit as they make it easier to repay your bills on time rather than encouraging you to fall behind.
Staying the Course While Paying Off Debt
Paying off debt can require means and motivation. A debt consolidation program can help by simplifying your bills and lowering your monthly payments. But even then, it can often be a stressful and time-consuming process that takes years to complete.
There's no shortcut, but you can look for ways to save money and put the extra funds toward your bills. And if you receive windfall gains, such as a tax return, consider how much you can use to pay off debt.
While you might not have many monthly bills if you've consolidated your loans, you can also look into the avalanche and snowball repayment strategies to reduce your credit card debt. These can help you repay your debt as quickly as possible, or keep you motivated while you check off one account after another. And if you're looking for help, many nonprofit credit counseling organizations also offer free debt and budgeting counseling with trained counselors.