Debt Reduction Vs Debt Consolidation

Couples who find themselves swimming in debt can find solutions in the forms of debt reduction and debt consolidation. Each solution is fairly different in how it works and how it affects your financial future. When analyzing either of these forms of eliminating debt, be sure to read all of the fine print and understand completely what is occurring to you financially.

Debt Reduction

Debt reduction is offered through a debt resettlement company who work with your creditors. All your debts are placed in one account and are paid off via a separate trust account that is set up by the resettlement company. Usually, a debt resettlement company negotiates with your creditors to bring your debt down by 40 to 60 percent. Your debt settlement company now deals with your creditors. If this happens, tax implications arise if your debt is negotiated down. The Internal Revenue Service deems debt resettlement as a gift. You will need to report it as such in your tax return.

Debt Consolidation

Debt consolidation is the act of taking out a loan to pay your outstanding debts. Usually, debt consolidation uses your home as collateral. The main benefit of choosing consolidation comes from the interest on unsecured debt being larger than the interest on the loan that comes out of consolidation.

Deciding Between Debt Reduction and Consolidation

Discuss with your partner which route you wish to go down when it comes to reducing your debt. Understand that even though your debt will be in the process of being paid off, your credit will still take a hit and will take some time before it has been repaired. The good news is that paying off your old debt is the first step toward making this happen. Make sure to note the risks involved in either debt reduction or consolidation. Debt consolidation means taking on another loan to pay off debt. Decide if that is something that you and your partner wish to do. You must understand the tax implications of debt reduction if you choose that option.

Impact on Your Credit Score

Debt consolidation and reduction impact your credit score in different ways. If you and your partner choose the debt reduction route, you should realize that it may take three to four years to eliminate your debt. When applying for credit, a bank or potential creditor will see that you are enrolled and deny you based on the fact that you already have your hands full with your current debt. Other problems may arise with your credit due to you having negotiating your way out of the full amount of your debt. Be sure to make your monthly payment to your debt reduction company on time or else your credit will be negatively affected. It is important to make sure that when you pay this monthly debt reduction bill that the company you are working with is making payments to your creditors on time as well. If the company fails to pay your creditors on time, it is your credit score that is hurt, not theirs. If you have chosen to go down the road of debt consolidation, your credit score will see a small uptick initially because it will look as if your creditors have been paid off. But, be sure to pay your loan on time and in full on a monthly basis or else your credit will go back down.

About the Author

Travis Ames has written for numerous publications since 2007 and has been writing instructional articles online since 2010. His areas of expertise are wide and include travel, politics, arts and entertainment, technology and finance. He currently lives in Portland, Oregon where he will begin teaching in the fall of 2011.