What is better debt consolidation or debt management?

Whether debt consolidation or debt management (also known as debt settlement in the US) is a better option for you depends on your personal financial circumstances. Bear in mind that paying less than the contractual amount can affect your credit score – even if you’re on a payment plan.

5 min read
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What does debt consolidation mean? 

Debt consolidation is where you combine your debts into a single monthly repayment. You do this by taking out a new form of credit, like a loan or credit card, which you use to pay off your existing debts.

The money you borrow through your new loan or credit card must cover the total amount you owe, including interest. Otherwise, you’ll just be adding to your debts instead of consolidating them.

What is the difference between debt consolidation and debt management? 

Debt consolidation combines your debts into one - but with debt management, you make single monthly repayments to the debt management company who splits it between your creditors. 

With debt management, you use a company to negotiate a new repayment plan with your creditors on your behalf - usually at a lower monthly amount than you currently pay. Your creditors will still expect you to clear the debt in full by the end of your plan.

The monthly repayment amount the creditors agree to will depend on your income and expenditure and affordability – plus their own criteria. You make repayments to the debt management company who then distribute the funds to your creditors as agreed.

Bear in mind, the company will usually take a fee for this out of your monthly payment - unless you use a debt charity, like StepChange.

Debt consolidation benefits and disadvantages 

There are benefits and disadvantages to debt consolidation, so you should consider these before deciding which course of action is right for you.

Benefits of debt consolidation 

  • reduced monthly repayments - consolidating your debt could reduce your monthly repayments into more manageable amounts
  • one single monthly repayment - having several payments going out at different times each month can be stressful to manage. Only needing to make one monthly repayment could make it easier to keep on top of your finances
  • you could potentially save money on interest - consolidating your debt may reduce the amount of interest you have to pay overall (if you can find a better interest rate than you’re currently being charged by your creditors)
  • you only owe one lender money – this can reduce stress and make it easier to keep track of who and what you owe

Disadvantages of debt consolidation

  • you’re not guaranteed acceptance for a debt consolidation loan or balance transfer card – so it’s best to use an eligibility checker to see whether you’re likely to be accepted before you apply – with no impact to your credit score
  • extra fees may apply - credit card providers often charge for balance transfers and there could be hidden fees involved when taking out a debt consolidation loan
  • interest could be higher than what you’re currently paying – so make sure you research the fees before applying for any type of credit
  • it may take longer to pay off your debt – for example if you spread out the repayments over a longer period

Debt management benefits and disadvantages

Carefully consider the pros and cons of debt management before deciding whether or not to persue it.

Benefits of debt management

  • more manageable repayment plan - if you’re struggling to afford your monthly repayments each month, you could try and negotiate a reduced amount
  • your creditors may agree to freeze interest and charges – depending on their discretion
  • the stress of creditors contacting you will be lifted - the debt management company manages communication with your creditors, so you shouldn’t get any calls from them asking you for payment
  • you will be debt free – once you pay your debts in full and complete the plan this will be reflected on your credit report

Disadvantages of debt management 

  • debt management companies usually charge a monthly fee – so you may wish to use a free charity instead, like StepChange
  • there’s no guarantee your creditors will agree to negotiate - your creditors aren’t legally obliged to accepted reduced payment plans and there’s nothing to say that they will
  • your credit score could be damaged – if you pay less than the contractual agreement amount to your creditors it will negatively affect your credit score and after three to six payments a default will be registered on your report for six years
  • secured loans, mortgages and other secured debts cannot be included – you will have to continue paying these separately on top of your debt management plan payments

Does debt consolidation affect your credit score? 

Debt consolidation can affect your credit score either negatively or positively depending on how you go about it.

How to improve your credit score 

  • making your payments on time and in full shows lenders that you’re responsible with managing money and will positively impact your credit score
  • paying off your debt sooner by taking out a debt consolidation option with a shorter repayment plan than before will mean your credit score increases – as long as you make your payments on time and in full
  • lowering your credit utilisation ratio to 30% or less - this relates to the amount you spend out of your total available credit limit on credit cards and overdrafts. By consolidating credit card and overdrafts into an instalment loan, you will reduce your credit utilisation ratio – which will boost your credit score
  • improving your credit mix - lenders may feel more confident lending to you if they can see that you can manage different forms of credit well (like credit cards and loans, for example). But you should only apply for credit if you need it and you can afford to pay it back

Ways your credit score may decrease 

  • NOT making your repayments on time and in full, you’ll accrue late fees and damage your credit score
  • taking out a debt consolidation loan over a longer term, you’ll be in debt for more time which means your credit score may not spring back as quickly
  • making lots of applications for debt consolidation – this can make you look desperate for credit and put some lenders off. Plus, every time you make an application it causes a temporary dip to your credit score
  • opening more lines of borrowing after consolidating your debt – this may harm your credit score, as your total debt will increase

How does debt management affect your credit score?  

When you enter into a debt management plan, you don’t pay the full amount owed in one lump sum. Because you’d pay less than the agreed amount each month, your credit score will be affected. Plus, lenders may think it’s risky to lend to you in case you can’t pay the full amount back – on top of your existing debt.

While this might not stop you getting credit, it’s likely to decrease your chances of getting the best deals. However, once your debt is paid off, any defaults will be marked as satisfied. Plus, any negative markers will automatically drop off after six years of registration, which should make you more attractive to lenders in the long run.

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