In another article I explained what is unsecured debt (link opens in a new page). So in order to decide what debt you can manage and what debts are out of control, you start by separating the out of control debt into secured and unsecured. Besides credit card debt, medical bills, personal loans, some business loans can also fall in the unsecured category. Mortgage and car loans belong to the secured pile.
What is consumer debt consolidation?
Debt Consolidation is the technique of gathering multiple credit card debt, loans and other liabilities and combining them into one. The individual who chooses debt consolidation does this by taking out a single loan to pay off the debt as a whole. Debt consolidation allows you to combine all of your loans into one loan, usually at a lower negotiated interest rate.
Debt Consolidation is also known as debt reduction because it consolidates all of your unsecured credit card & other debt into a single payment.
Although all sounds nice on paper, the major caveat is the overall time to repay the consolidated credit. As a rule of thumb, think of consolidation as taking a longer time to repay your debt while lowering your monthly payments.
Debt consolidation companies make their money from the difference between the overall amount repaid after debt reduction (higher) and the initial amount owned to several lenders prior to consolidation (lower).
When to choose debt consolidation?
For a debt consolidation program to work, you must reduce your total debt owed month by month. Studies conducted in the US have shown that 78% of debt consolidators see their debts grow back to original levels after the original consolidation, mainly because the consolidation is seen as a solution and not as a tool by itself – once monthly payments become manageable again, they revert to over spending and going on shopping sprees.
Experts in the finance industry suggest that your outstanding debts (that includes credit card & mortgage debt) should NOT exceed 36% of your Gross monthly income. This 36% is also referred to as the Debt-to-Income ratio. You can calculate your own Debt-to-Income ratio using the formula below:
What is debt negotiation?
Debt negotiation or more commonly referred as “debt settlement”, is when a specialized company (sometimes law firm) is contracted to represent you in front of your creditors. They negotiate a settlement with each creditor, normally between 30-60% of the owed amount, sometimes less or more. You make one monthly payment that is normally automatically drafted out of a checking or savings account. Those funds are then deposited into 3rd party “Special Purpose Account” in your name. As the money builds up in your settlement account or “Special Purpose Account”, the company would reach a settlement with your creditor, pay them off and move on to the next creditor. This is done over periods of 12 to 36 months. Debt settlement plans should not be over 36 months and you should keep a communication channel open with the company for the entire duration of the process. The company will generally design a custom strategy for your specific mix of debt and coach you on how to handle any communication from the creditors while the settlement is taking place.
The major drawbacks are the qualifying process (debt negotiation companies are prone to accepting only debt they know they can settle), the risk of lawsuit in case of communication breakdown (your creditors might not accept the terms offered by the settlement company and still sue you) and the tax liability on the forgiven debt (can be seen as income by Revenue).
When to choose debt negotiation?
If you cannot afford your debt, want to avoid filing bankruptcy or you have high unsecured debt you might want to go the route of debt settlement. This is also a good method to put a communication buffer between you and your creditors and bring professional negotiators on your team – their expertise can cut your monthly payments by 30-70%, reduce the overall debt by 40-60% and free your schedule from hassle, allowing you to jumpstart your recovery.
This quick review of debt consolidation and debt negotiation should be enough to get you started – follow this blog for more tips on how to deal with debt.
Related posts:
- What is unsecured debt? The base definition of unsecured debt
- Question About Savings Account Versus Credit Card Debt?
- Should I Use My Savings To Pay Off Most Of My Credit Debt?
- Why Does The Australian Govt Tax The Sh_t Out Of People Who Choose To Have Savings Instead Of Own A Home?
- Take The Money In Savings And Pay Off Credit Card Debt?