When it comes to dealing with your debt, you can take many different approaches. We compare two of those paths below: debt consolidation and debt restructuring.
There are many different options for dealing with debt, but having so many choices can be both a blessing and a curse.
On the positive side, you have a ton of different ways to approach your journey toward a debt-free life. On the negative side, many people don’t understand the key differences among these debt relief methods.
Two of the most common but often misunderstood debt relief options are debt consolidation and debt restructuring. If you are not a financial expert, you probably don’t know the difference between these methods. Even some debt professionals use the terms interchangeably.
Here are the key differences between these approaches. Understanding these differences can help you determine the best option for your situation.
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What’s the definition of debt consolidation?
In the simplest terms, debt consolidation is the process by which you turn many separate debts into a single debt. In doing so, you eliminate the stress of having to make several different monthly payments. With any luck, you also reduce the amount you pay on your debt, both now and overall.
There are several different forms of debt consolidation. They all accomplish the same goal but do so through different means. The most common types of debt consolidation are:
- Debt consolidation loans
- Balance transfer credit cards
- Debt settlement
Debt consolidation loans
Debt consolidation loans are by far the most popular and common form of debt consolidation. They are likely what comes to mind when you think of debt consolidation.
With debt consolidation loans, you take out a personal loan that is large enough to pay off all of your other debts at once. You pay off those debts with this loan, which essentially rolls the debts into the new loan. Then, you focus on paying down the loan.
Ideally, a debt consolidation loan accomplishes a few different things. Most obviously, it should enable you to pay off several of your other debts at once as you consolidate them into a single loan.
In the best-case scenario, it also gives you a lower interest rate and more forgiving terms than the original debt you are consolidating. If that’s the case, you should see monthly payments come down, and you should end up paying less interest on your debt over time.
A variety of lenders offer debt consolidation loans. This includes banks and credit unions, but plenty of lenders specialize in debt consolidation, such as Reach Financial.
Balance-transfer credit cards
Using balance-transfer credit cards can seem a bit counterintuitive. After all, many people struggling with debt got there by overspending on their credit cards. So, why would they want to get out of debt by opening up a new card?
However, if you use a balance-transfer credit card correctly, it can be a great tool for consolidating debt.
When using this option, you apply for a new card with a high credit limit and a much lower interest rate than your current cards offer. Ideally, you will qualify for a card with a 0% introductory APR offer, which lets you avoid accruing interest for a set number of months.
Then, you consolidate all your debts onto this new card. Before the card starts to accrue interest, you devote significant resources toward paying it off. Since the debt is not accruing interest, every dollar you pay each month goes toward the principal balance.
By using this approach, not only do you consolidate debt, but you also essentially stop the clock on the debt’s interest, enabling you to get out of debt much faster.
Debt settlement
Debt settlement can be the most difficult form of debt consolidation to understand because it is different from most other forms of consolidation. However, when done right, it accomplishes the same goal as the other methods of consolidation.
With debt settlement, you work with a professional debt settlement company that acts as a negotiator and buffer between you and your creditors. Instead of paying creditors, you pay into an account managed by the debt settlement company, essentially consolidating your debt payments into a single payment.
Your creditors won’t like that you have stopped making payments to them. However, a good debt settlement company is more than willing to take the heat while working on your behalf.
After a while, you should have a sizable amount of money in the savings account managed by the debt settlement company. At this point, the debt settlement company will spring into action by approaching your creditors and asking them to take a lump-sum payment now while forgiving the rest of your debt.
For creditors, saying “yes” to such a proposal is often an easy decision. Instead of getting nothing and devoting resources to harassing you, they can take a lump settlement and put the whole ordeal behind them. You might be surprised how many creditors take the deal.
Note that many other forms of debt consolidation exist, and plenty of companies say they offer debt consolidation services. If you are interested in pursuing debt consolidation, make sure to do your research and consult with a professional before you decide how to go about it.
What’s the definition of debt restructuring?
When done correctly, debt restructuring accomplishes many of the same things that debt consolidation does. That is why so many people tend to confuse the two concepts.
Like debt consolidation, debt restructuring can get you:
- More forgiving terms on your debt
- Better interest rates
- A clearer, more manageable path toward a debt-free life.
With debt restructuring, you focus on renegotiating the terms of a single debt directly with your lender. By restructuring the debt, you make it easier to pay off.
Why would lenders entertain this type of renegotiation? After all, they already require you to pay down your debt on terms that are more favorable to them. So, why would they agree to take less?
Lenders agree to debt restructuring when the borrower doesn’t seem to have many other options. For example, the borrower might be on the verge of bankruptcy. The lender sees this reality and realizes that unless it restructures the debt, it is unlikely that it will continue to receive payments from the borrower.
The truth is that debt restructuring often helps both parties.
Debt restructuring can occur in bankruptcy situations, including Chapter 7 and Chapter 11 for both individuals and businesses, or Chapter 13 for individuals. During bankruptcy proceedings, debt restructuring is part of a larger structured effort to help the individual filing for bankruptcy get a handle on his or her finances and pay back creditors over a set period.
What’s the difference between debt consolidation and debt restructuring?
Now that we understand the definitions of debt consolidation and debt restructuring, let’s compare and contrast these approaches and how they apply to different situations.
Many debts versus a single debt
One of the most obvious differences between debt consolidation and debt restructuring is the intent.
By definition, debt consolidation focuses on multiple different debts at once. It promotes the goal of making the debts more manageable by attempting to consolidate them into a single debt instrument.
On the other hand, debt restructuring typically focuses on a single debt, although you could conceivably restructure multiple different debts at the same time.
Consolidation usually makes more sense when dealing with multiple smaller debts, such as debt associated with several credit cards. Restructuring makes more sense when dealing with single, larger debts, such as a mortgage.
A simple financial move versus a negotiation
Debt consolidation is something you can do on your own. While it often makes sense to work with a professional who will in turn work with your creditors in the process, it’s not a requirement. It is possible that you will find a solid debt consolidation loan to pay off all your debts on your own.
On the other hand, debt restructuring is a negotiation between you and your creditors. It’s not something you can just wake up and decide to do. Your creditors need to be open to the process as well.
Your creditors are likely only going to consider restructuring your debt if you can show significant financial duress. Otherwise, they will just try to hold you to the original terms of your loan.
Trying to preserve credit versus limiting credit damage
Done right, debt consolidation can be a smart move to preserve your credit. By taking out a debt consolidation loan or opening up a balance-transfer credit card, you are making it easier to keep up with your debt payments while also maintaining the health of your credit score.
On the other hand, debt restructuring could damage your credit. That is because it often is so closely tied to bankruptcy proceedings. Bankruptcy is a long-lasting black mark that can remain on your credit report for between seven and 10 years, depending on the type of bankruptcy.
While debt restructuring can be a smart financial move, it’s also often damaging to your credit.
What are the pros and cons of debt consolidation?
On the pro side, debt consolidation can help reduce your stress, lower your payments, and give you a clearer path to becoming debt-free.
Debt consolidation reduces stress simply by reducing the number of creditors that you have to deal with. Keeping track of multiple different minimum monthly payments can wear anyone down after a while. If for any reason you fall behind, matters get exponentially worse, as you can end up dealing with harassing calls from multiple different creditors each day.
Consolidating your debt can help you avoid those kinds of situations.
In addition, by reducing your interest rates, you end up paying less over time to your lender, and you may end up paying less per month as well. Not all debt consolidations achieve this, but many do. It should always be your goal to save money as well as consolidate your payments.
The result of simplifying and streamlining your debt is a clearer path to a healthy financial future. By focusing on paying off your consolidated debt, you can eventually mark the date on your calendar that you become free of debt — hopefully for good.
However, debt consolidation has cons as well. The major con is that debt consolidation does not fix your underlying financial problems. Debt consolidation will free up a lot of credit very quickly, which could tempt you to start running up debts again. You might even end up worse off than you were before.
What are the pros and cons of debt restructuring?
The pros of debt restructuring are that you can potentially reduce your interest rate and the amount of debt that you must repay to a creditor. Your debt payments may even bundle into a single payment each month, which comes with many of the same benefits as debt consolidation.
That said, debt restructuring usually isn’t a positive event. Restructuring through bankruptcy negatively affects your credit for at least seven years, and often more.
Additionally, even if a significant amount of your debt is forgiven, you might still have to pay taxes on the forgiven amount. Finally, not all debt is eligible for restructuring. Specifically, you cannot restructure student loans, which are often an individual’s largest financial burden.Whatever you decide to do about your debt problems, National Debt Relief can help. We’ve aided people all over the country with getting control of their debt, and we would be happy to walk you through your options. Contact us today!
