You're ready to tackle it and get out from under your finances, but you're not sure of the best way to do it. How can you know what option will be best for the kind of debt you're facing? This post will tackle the difference between debt consolidation (often from a debt consolidation loan product) and debt management company/program so you can determine which option is best for you. They're very different, but the differences may not seem so obvious to those who aren't “in the know” on financial terminology.
The Difference between Debt Consolidation and Debt Management
What is Debt Consolidation?
Debt Consolidation is a means to get rid of your debt fast by combining all of your debts into one big debt (often called a “debt consolidation loan”) at lower interest rates. You'll apply for the loan because it offers a much lower interest rate than what you're currently paying and they'll pay off your creditor individual.
There is this perception that debt consolidation is for people:
- in dire straits
- who have lost everything
- or are being harassed by creditors at every hour of the day.
But it isn’t. It is increasingly a more popular option for those struggling to keep up with student loan payments, their mortgage, or medical debt. And no one talks about it because of the perceived amount of shame involved.
Typical debt consolidation loans work where you take out a loan at a different interest rate with a separate company from other creditors, and you use those lower interest funds to pay off your other creditors, thus “consolidating” your debt into one monthly payment.
Upstart is one such company I like where you can do this. If you've got less than $10k in balances, researching other balance transfer offers with cards can be a great way to lower interest rates without getting a heavy (like a debt management company or service involved.)
What Can a Debt Consolidation Loan Do for Me?
- Pros: This helps you pay less interest, which helps you get out from under your debt faster. While it might seem backward to take on debt in order to get out of the debt you've gotten yourself into, it can actually help you save a lot of money in the long run.
- Here's an example: Let's say you have a credit card with a $3,000 balance that charges 20% interest annually, with a payment of $100 a month; a student loan with a $10,000 balance that charges 10% annually, with a payment of $200 a month; and a car loan with a balance of $5,000 that charges 15% annually, with a payment of $250 a month. You'd be paying around $550 a month towards those debts, as well as interest from each of your debts. The credit card would wind up with $1193.50 in interest, the student loan with $2989.70, and the car loan with $1535.41. That's a total of $5718.61 a year in interest alone. Using debt consolidation, you'd still pay $550 a month. However, you'd only be paying $3105.93 in interest each year, for a savings of $2612.68 per year.
- Cons: While this can be a great option for many households, it's important to remember that this is still a loan. You're still subject to monthly payments and interest rates, and you'll still experience issues if you miss a payment.
Before beginning any kind of consolidation, talk to a trusted financial professional (or you know, do your homework on interest rates and fees) to make sure it's a good fit for your credit needs.
What is a Debt Management Company?
Debt Management companies work with creditors to help you reduce your interest rates and monthly payments. Most debt management plans take 3-5 years to pay off. These companies create plans that help you pay off unsecured debts like medical bills, student loans, and credit cards while allowing you to regain control of your finances.
- Pros: Many of these companies will help you create a plan that works around your needs and income. You'll know ahead of time what monthly payment you need to make on your debts. For those who aren't familiar with budgets, or who don't have a lot of experience in managing your finances, working with these companies is a great way to create realistic budgets and goals. Credit collectors are also less likely to call you, as they can see that you are working on paying them back.
- Cons: However, you'll want to be careful when deciding to work with a debt management company. Make sure there are no complaints against them from the Better Business Bureau, or the state Attorney General's office. You'll also want to make sure the company is licensed to help you. Watch out for hidden fees along the way.
- One of the biggest downsides of using a debt management company is that your credit score is likely to drop. Because these companies renegotiate your financial obligations, they can create late payments or close accounts that you have a good history with. However, this change isn't usually long term and may help you improve your credit in the long run.
How to Decide Which is Best For You
A debt consolidation loan is more of a tool to help you reduce your debt, while debt management companies provide you with an itinerary of how to get there. If you believe you can manage your debts, but you just want to decrease the overall amount of interest you end up paying each year, debt consolidation is the way to go.
However, if you're unsure of how to change your financial behavior, and need help figuring out how to get out of your debt situation, a debt management company can help you do that.
Take a look at your spending history. Look at all of your accounts together, and figure out if this is something you think you can manage on your own. Don't be afraid to ask for help to get to a better life! And, obviously please, whichever option you decide to go with, make sure you shop around to get the best rates and services available.
Hear from someone who used a debt management program
Full disclosure: I've never used a debt management company, although I have used a consolidation loan to pay off higher interest balances in the past. It's a great way to save money on interest if you have a solid financial history and good credit.
But I wanted to hear about the benefit these debt management companies can provide to those who are – literally -drowning in debt. My very brave friend, Robin, paid off $30,000 dollars of debt through one such program, and I personally believe this video is one of the best in the “Awkward Money Chat” series.
In the video below, Robin talks quite candidly about how to pay off credit card debt, and her story is amazing because she was successful!