Being in debt is stressful, and that’s why you’ve decided to do something about it. Resolving to improve your financial health is the crucial first step. But now comes the added stress of figuring out which of the many debt relief options is the right one for your financial situation. Two of the more popular options to consider are consumer credit counseling and debt settlement.
Either one may be the right solution for you; but before you make a decision with regard to credit counseling vs. debt settlement, it’s important to understand the pros and cons of each. We’ll explain how both work—and who they work best for—so you can get one step closer to getting out of debt.
What is credit counseling?
A counseling session is a great place to start if you need help with your financial affairs. The professionals at credit counseling agencies are highly skilled at analyzing your information, outlining available options, and designing money management programs that can help eliminate not only your debt but the stress that goes with it.
Credit counseling can:
- Give you the tools you need to get your finances under control.
- Help you put processes in place to ensure you make your payments on time, while growing your savings.
- Help consumers who are unsure how to approach their creditors about negotiating payment plans or settling their debts.
Credit counseling can be done in-person, over the phone, or online. A certified counselor will spend an hour or so with you to gather information and get a general idea of your economic situation.
Credit counseling agencies typically provide five main services:
- General budgeting
The counselor will want to know about your income, assets, expenses, and financial goals. They’ll ask about the circumstances that got you into debt, and what you’ve done so far to take care of it. At the end of the first session, you and the counselor will discuss ways to budget and may suggest that more counseling would be helpful.
- Debt management plans
Depending on your personal situation, the counselor may recommend a debt management plan (DMP), which can be a savvy debt relief strategy for some. This is a personalized plan that will allow you to consolidate your debts into one monthly payment with a lower interest rate. If you enroll in a DMP, you can usually expect your debt to be cleared within three to five years.
- Bankruptcy counseling
If it turns out that the best method for putting your debt behind you is bankruptcy, you’ll be required to undergo two sessions of credit counseling: “pre-filing counseling” and a pre-discharge counseling session at the end of the bankruptcy process (before your debts are discharged). These meetings are designed to inform you about the bankruptcy process and educate you on how to avoid getting into debt again.
- Student loan counseling
If you’re having difficulty paying back student loans, the counselor will review your entire economic situation and may speak with your loan issuers. They’ll take into consideration your expenses, loans, and other debt to figure out the best path for you. The federal student loan repayment options available to you will depend on whether you’ve been able to make payments on time, or whether you’re in default on your loan.
- Housing counseling
This type of counseling can help if you’re having trouble paying your rent or mortgage or need advice on how to buy your first home. The counselor can advise you on issues like how to avoid foreclosure, protect your credit, create a budget, and can provide other helpful resources.
How do debt management plans (DMPs) work?
Most consumer credit counseling agencies will provide some, if not all, of the services outlined above, but they’re primarily known for the DMPs they offer. If appropriate for your situation, enrolling in a DMP could be the answer you’ve been looking for in your quest to become more financially stable.
While credit counseling is usually free, if you enroll in a DMP, you will pay a fee for the service. As far as credit counseling vs. debt settlement is concerned, DMP is a less drastic form of debt relief than debt settlement (or bankruptcy), which we’ll compare later.
DMPs typically last from 36 to 60 months and—if you qualify—are a methodical way to pay down your outstanding debt. A DMP combines multiple debts into one monthly payment, which you’ll make directly to the credit counseling agency. The agency will then distribute these funds between your creditors and negotiate with them to reduce the amount of interest you’re paying on your balances.
This process is different from debt settlement, since your debts are not settled for a lesser amount. In fact, the monthly payment plan could end up being higher than what you’re currently paying.
Pros and cons of DMPs
|Effective method of paying off debt faster||Restricted to credit card debt—can’t be used to pay off medical bills, taxes, or student loans|
|Easier to keep track of payments with debts combined into one payment||Plans can take 3 to 5 years to complete|
|Could save money with late fees removed and interest rates reduced||Unable to use credit cards or get new ones (may be allowed to keep one under certain limited circumstances)|
|Avoids the need to deal with collection calls||If you miss a payment, program will end|
|Less severe impact to your credit than debt settlement||Not all creditors participate in debt management plans|
What to look for in a credit counseling agency
Like any other major purchase or decision, it’s worth taking the time to research your options. Decide what you’re looking for in an agency and go online to learn what other consumers have to say about them and how they rate them. In addition, ask for referrals from friends and family, your financial institution, or your local consumer protection agency.
The first counseling session should be free. During this session, your counselor will:
- Review your entire financial state of affairs with you
- Help you calculate your monthly income and expenditures
- Brainstorm ways for you to make more money and spend less
- Review your credit card debts, their interest rates and terms, and your payment histories
It’s important to choose a legitimate agency, so you’ll want to start by checking whether they’re licensed in your state and accredited. Accredited agencies employ certified counselors and have strict guidelines concerning data security and customer service.
Be aware that not all agencies with a “non-profit” status are legitimate. This status doesn’t automatically mean that the agency’s services are free of charge, and they may, in fact, charge high fees that are not immediately obvious.
What to expect from a debt settlement plan
Also known as debt relief or debt negotiation, debt settlement is best suited for consumers struggling with a large amount of unsecured debt from credit cards, medical bills or private student loans. It won’t work for debt from auto loans, mortgages, or federal student loans. If you’re having trouble keeping up with the minimum payments on your credit cards and you’re considering bankruptcy or credit counseling, debt settlement could be the right solution for you.
Debt settlement vs. credit counseling: how it differs
Debt settlement is different from other types of debt relief programs. Like the debt management plan mentioned above, the company’s representatives negotiate lower interest rates and send the payments to your creditors on your behalf. However, with a debt settlement program, you still fund the payments to your creditor, but the debt settlement company does not control your funds and does not pay your creditors.
You could try to negotiate with your creditors on your own, but it can be very stressful. Unless you’re experienced in this type of financial discussion, you may not be successful in getting your creditors to reduce the amount you owe as much as a debt settlement company that has established, long-term relationships with those companies can.
How the debt settlement process works
When you enroll in a debt settlement program, you make a monthly deposit into a special purpose or dedicated account. The amount you deposit is based on how much debt you have, how soon you want to be out of that debt, and how much you can afford each month.
Once the balance of your account grows to a certain amount, the debt settlement company will begin contacting your creditors to negotiate settlements, often for less than the amounts you owe. Since the company cannot begin negotiations until there is enough money in the account that they can offer as a settlement, it may take several months in the program before any settlements are reached.
The importance of working with a reputable company
Unfortunately, while the debt settlement industry has helped thousands of people, it also has its share of disreputable companies. That’s why it’s important to choose a reliable one with a good track record. Check to make sure the company you’re considering is accredited by the Better Business Bureau (and check user reviews) and make sure they adhere to standards established by the American Fair Credit Council (AFCC).
Pros and cons of debt settlement
|Affordable monthly program deposit||Need to research to avoid disreputable companies|
|Can resolve debts faster than making minimum payments||Individual negotiations needed for each creditor|
|Easier to qualify for than a loan||Negative initial impact on credit score with missed payments while settlement is negotiated|
|Saves money by letting you often pay back less than original debt owed||Fees charged—usually a percentage of the amount owed on the account|
|An alternative solution to bankruptcy||Not all creditors work with all debt settlement companies|
Credit counseling vs. debt settlement: what’s the right path forward?
If you are struggling with debt or are just worried about falling behind on payments, it might be time for a new approach. If you think that debt settlement might be a good option, Freedom Debt Relief can help you better understand your all options for dealing with your debt, including our debt settlement program. Our Certified Debt Consultants can help you find a solution that solves your financial needs. Find out if you qualify right now.