Credit Card Debt Consolidation or Settlement: Two Debt Resolution Titans

Federal Reserve statistics bluntly confirm that millions of Americans are living on the edge of a precipice called credit card debt:

• Nearly 50% of card holders in the U.S. carry a credit card balance
• Outstanding credit card balances top $800 billion
• The average rate of interest on a credit card is 14.9%
• Forty percent of American households earn less than they spend

Fortunately, there are two highly effective strategies to protect borrowers from falling into debt’s abyss: 1) debt consolidation and 2) credit card debt settlement.  Indebted individuals faced with the question of “credit card consolidation versus debt payment” must carefully weigh the pros and cons of these two popular methods that help to eliminate credit card debt.  What follows is an in-depth discussion of the advantages and disadvantages of each of the two options and alternatives to bankruptcy.

1. Credit card debt consolidation

This is effectuated by combining the outstanding, high-interest balances on several credit cards into a low or zero-interest credit card or a low-interest loan.  Ideal candidates for this debt resolution approach are individuals (1) whose income is insufficient to cover their credit card balances, (2) are unable to pay the minimum amount due, and/or (3) have pending balances with multiple credit card accounts.  Also known as loan consolidation, debt consolidation involves the substitution of multiple loans with one new loan that is usually paid off in 3-5 years.  Before applying for a consolidation loan, consumers should ensure that the new loan will cost them less in interest and fees than what they were paying their previous lenders.  Credit card debt may be consolidated via a second mortgage, a home equity loan or home equity line of credit, or a 0% credit card.

Credit card consolidation offers numerous benefits including the following:

• Credit rating is not negatively impacted over the long term
• Lower rates of interest
• Simplification of financial management and budgeting
• Convenience of a single monthly payment as opposed to several payments to different creditors

Conversely, this debt resolution method presents a few disadvantages or obstacles, such as:

• No diminishment of the principal
• Requirement of sufficient equity to secure the low-interest loan
• Potential loss of collateral (i.e. home) in the event of the borrower’s default or late payments
• Payment of points (1 point= 1% of the sum borrowed) in addition to interest charges

2. Credit card debt settlement

Also referred to as debt negotiation, this method involves a credit card company’s agreement to forgive a significant amount of the customer’s debt in exchange for the latter’s payment of the settlement.  The customer must be delinquent in his or her payments and show financial hardship.  On average, debt negotiation can knock out 40-75% of a borrower’s credit card debt.  This is the most expeditious and affordable route to a debt-free state without filing for bankruptcy.  Credit card debt settlement offers a drastic reduction of overall debt since borrowers are only required to pay a portion of the sum owed.  It is a recommended measure for individuals who (1) do not qualify for debt consolidation, (2) cannot realistically envisage a repayment of the accounts, (3) are saddled with too much debt and/or (4) are considering bankruptcy.

Typically, a debt settlement firm negotiates with the credit card company on the client’s behalf to settle for an amount below the outstanding balance.  Upon satisfaction of the settled debt, the credit card company reports to the three credit bureaus that the debt has been “Settled for less than full amount” or “Paid”.  A credit card debt settlement usually takes 1-3 years to complete and offers the following benefits:

• Substantial interest savings
• No payment of over-the-limit fees
• Significant improvement of the borrower’s debt-to-income ratio, which facilitates the obtainment of a new loan

On the downside, a credit card debt settlement often results in:

• A negative impact on the credit score on the short term due to the presence of the notations “settled” or “charge-off” in the credit report (which may remain for up to seven years)

Potential taxation on any canceled debt exceeding $600