Credit Counseling vs. Debt Settlement: Which is Better?

It’s very easy for individuals and households to find themselves in debt, particularly in the current economic situation. Prices are increasing but salaries are not following, which means that many people are struggling with debt to cover everyday expenses. An unexpected expense like a broken dishwasher or a problem with your car can easily derail your finances and increase your debt to unmanageable levels. That’s where credit counseling and debt settlement come in.

Both options have their advantages and disadvantages of debt relief but operate in fundamentally different ways. Credit counseling aims to help people understand their finances better and organize them in a way that leaves enough space to repay their debt. Debt settlement is based on the idea that repaying the full debt is non-feasible and you are asking to repay only part of your existing debt.

This post explains how credit counseling can help and when debt settlement becomes a viable and welcome solution.

What are credit counseling services?

Credit counseling is a service typically provided by nonprofit organizations that helps individuals manage their debt and their financial habits through education and structured repayment plans. Unlike debt consolidation loans, credit counseling does not require you to qualify for a loan. Therefore, you do not need a good credit score to qualify for it.

Many people struggle with their finances because they don’t know how incomes, expenses, and interest rates function. An initial credit counseling session offers the basics of personal finances and takes a look at a person’s finances to assess how they can squeeze their finances to repay their debt while still leading a normal life.

How Credit Counseling Works

Initial Consultation: The process of credit counseling begins with a free consultation with a certified credit counselor. During this session, the counselor will review your financial situation, including income, expenses, and debt levels. The goal is for the counselor to get a clear picture of how much you owe, how much you earn, and how much financial room is available for you to repay your debt in a manageable way.

Budgeting Assistance: The counselor can help you create a budget to manage your finances more effectively. The credit counselor may also suggest you cut out some expenses or bundle services so you get better prices and have more room to pay your debt. You will probably be required to lead a more restrained life without frivolous purchases until you pay down your debt.

Debt Management Plan (DMP): If appropriate, the counselor may recommend a Debt Management Plan (DMP). Under a DMP, multiple unsecured debts, such as credit cards debt, are consolidated into single monthly payments made to the credit counseling agency, which then distributes payments to creditors.

Negotiating Terms: To help you achieve better results, the counseling agencies may be able to convince your creditors to offer lower interest rates and waive late fees so your overall debt is more manageable and you have more chances of repaying it.

What is debt settlement?

Debt settlement involves negotiating with your creditors to accept a lump sum payment that is less than the full amount owed, effectively forgiving a portion of the debt. Debt settlement is the right choice if you have already tried debt counseling and debt management and you still can’t repay your full debt on your current income.

If you want to avoid filing for bankruptcy but still need to reduce your level of debt to an amount that you can safely repay, then debt settlement is probably the best way forward for you.

How debt settlement works

Hire a Debt Settlement Company: For the debt settlement process to be successful, you should work with experienced debt settlement companies that will negotiate with you debt creditors on your behalf. You want a professional debt specialist to support your case and stand up for you.

The first step the settlement company will ask is for you to establish a dedicated savings account to be used for payments to your creditors. Clients entering into a debt settlement program are in a state of financial hardship so they may find it difficult to continue to pay creditors and put funds into their savings account. Therefore, many clients choose to stop making payments to their creditors while they are in the program. This actually helps the program to be more successful as creditors are less likely to negotiate a settlement while an account is current.

Accumulate Funds: You accumulate funds in the dedicated savings account to build up enough money for a settlement offer. Depending on your debt balances, this could take a few months or longer to save enough money to settle your balances.

Negotiation: The settlement company negotiates with credit card companies to accept a reduced payment — usually a percentage of the total debt owed. Why will creditors accept a deal? Because if they don’t, they risk losing the full amount of the debt. At least, with debt settlement they are still getting some of the money they are owed.

Settlement Agreements: Once an agreement is reached, the settlement payment is made, and the debt is considered settled.

Pros and Cons of

Credit Counseling and Debt Settlement

Credit counseling vs. debt settlement: which one is best?

When Credit Counseling is Better

Steady Income but Overwhelming Debt

If you have a stable income but are struggling to manage high-interest debt or multiple debt payments, credit counseling can be helpful. With a little re-organization of your expenses and a more frugal life for a couple of years, you should be able to overcome your debt situation.

Debt Management Plans can help you consolidate payments. If this comes with a lower interest rate, then you have made your debt more manageable.

Preserve Credit Score

Do you want to buy a home or a car in the near future? Credit counseling doesn’t impact your credit score, which means you will be able to get a better deal on your future loan’s interest rate. A debt management plan will be mentioned in your credit reports but will not have the severe negative impact associated with debt settlement or bankruptcy. If you successfully complete your debt management plan, you should even witness an improvement of your credit score over time.

Need for Financial Guidance and Education

Many people just need some professional guidance about budgeting and financial planning. Credit counseling organizations provide valuable education and support and include knowledge that you will find necessary throughout your lifetime.

Certified credit counselors may help you create a realistic budget, teach you better money management skills, and offer ongoing support to help you save and stay on track.

Managing Unsecured Debt

Credit counseling is particularly effective for managing unsecured debt, such as credit card balances and personal loans.

Commitment to Long-Term Repayment

Credit counseling typically requires a long-term commitment, usually 3 to 5 years, to pay off debt. You have to stay the course: a missed payment can make your creditors pull out of the deal. If external pressure helps you stay disciplined, then credit counseling agencies can be the right option for you.

When Debt Settlement is Better

Significant Financial Hardship

If your income is simply not enough to cover your everyday expenses and repay your debt, then debt settlement might be the best option for you.

Severe financial hardship can happen to anyone: job loss, medical emergencies, divorce or mental illness can seriously impact a person’s ability to earn a living. If you feel that paying your creditors is impossible, then debt settlement may be a more viable option.

High Debt-to-Income Ratio

When your debt-to-income ratio (DTI) is over 50%, then a large portion of your income is used for paying your debt and you don’t have enough money to cover your life necessities. Debt settlement can provide relief as it can lower the overall amount of debt owed.

Inability to Qualify for Other Debt Relief Options

If you do not qualify for debt consolidation loans (perhaps you have a poor credit score) or have already worked with a Debt Management Plan but failed to keep up with it, then debt settlement might be your best alternative. Debt relief companies can negotiate with debt creditors on your behalf to accept a payment that is less than the total debt owed.

You don’t mind credit score impact

If you don’t plan on buying a home or a car or applying for a new credit card in the next 7 years, then debt settlement is a viable solution. Your credit score will take a hit, since you will stop payments to creditors and negotiate for less than the full amount owed. It’s a trade-off that requires looking ahead of your current situation.

Credit counseling vs. debt settlement

Credit counseling is generally better for individuals who have a steady income and want to preserve their credit score. If a little financial guidance and a long-term repayment plan can help them repay their debt, then it’s a good choice. Although they will lead a more frugal life for a few years, they will come out of credit counseling debt-free.

Debt settlement is for people who face significant financial hardship and high debt-to-income ratios. These people often have already tried other debt relief options but simply can’t afford to pay back their full debt. If they can accept the credit score impact in exchange for substantial debt reduction, then they should settle their debt with a debt settlement company.

Take Control of Your Finances Today!

Are you overwhelmed by debt and unsure where to turn? Are you struggling to pay back your full debt? Looking for a reputable credit agency? Partner with us to manage your debts effectively, negotiate with debt creditors on your behalf, and help you improve your credit rating over time.

Contact a ClearOne Certified Debt Specialist today at 866-481-1597 and get a free savings estimate to see how much debt settlement can save you. Reach out to us and take control of your life again!