Debt consolidation is often mistaken for debt settlement or credit counseling, but there are important differences among all three.
With a debt consolidation loan, people take out one larger loan and use the proceeds to pay off all their smaller credit card debts. People who use these services make one, hopefully smaller, monthly payment to pay off the new loan. Some debt consolidation loan companies may also work with the creditors to lower interest rates or to waive late fees.
Credit or debt counseling usually involves meeting with a credit/debt counselor and is typically a very low cost. Counselors work at many locations across the country and may have many offices in each State.
In a credit counseling program, a person and his or her creditors create a debt repayment plan, which is a voluntary repayment schedule worked out to include reduced fees or other debts. A person makes payments to the debt consolidation agency, which sends that money directly to their creditors.
Both of those methods are generally geared toward avoiding default of a debt.
But debt settlement is just the opposite. Some very shady debt settlement companies, sometimes called debt negotiation companies, do not negotiate with a persons creditors directly. Instead they wait until the overdue debts have been turned over to a collection agency and only then start the process of negotiating for a lower repayment amount.
With these shady debt settlement companies, debtors typically pay an upfront setup fee capped by state law at 5 percent of the persons debt . Most of these shady companies often charge additional fees, capped at 20 percent of the persons debt. So if a person owes $100,000 they could pay up to $25,000 to the company, not their creditors.
