Two possible ways to regain control of potential runaway debt — while minimizing the impact on your credit score — are debt consolidation and debt management. The former involves taking on new debt to get existing debt under control, while the latter seeks to achieve the same goal through an organized repayment plan.
So, which is better, debt consolidation or debt management?
Let’s look at each of them in more detail.
Debt Consolidation Pros
Accomplished in a number of different ways, the upshot of debt consolidation — as the term implies — is the gathering of all of your outstanding debts under the cover of a single instrument. This makes your debt obligations easier to satisfy each month. It can also result in lower interest rates, which can return significant savings over the long term.
The most common forms of debt consolidation include credit card balance transfers, personal loans, home equity loans and home equity lines of credit. In terms of interest rates, home equity options usually the greatest advantage. However, they entail a rather significant risk too — we’ll give you more on that a little later.
Consolidation also reduces the number of bills of which you’ll need to keep track of each month — and you’ll still have access to your credit accounts while you’re paying down your debt.
Debt Management Pros
When you think about it, a debt management program is really just another form of debt consolidation. After an evaluation of your finances by a credit counsellor in which it is determined that you’re a viable candidate for a debt management program, the counsellor will negotiate with your creditors in an effort to lower your interest rates and get fees that may have accrued either reduced or forgiven.
Rather than paying your creditors directly, you’ll make a single monthly payment to the management organization, which in turn will forward payments to your lenders.
Debt Management Cons
While management also has the effect of consolidating your debts into one payment, you’ll be prohibited from using your existing credit accounts or opening new ones while you’re paying off your debts.
Further, debt management typically applies only to credit card debt. Student loans, mortgages, auto loans and personal loans are usually ineligible for management programs. However, if your credit score makes getting a consolidation loan unfeasible, management can be a good way to go.
Debt Consolidation Cons
Each of the consolidation methods entails a variety of fees and expenses, so those costs must be considered when evaluating the suitability of a debt consolidation solution for your particular circumstances.
Home equity lines of credit in particular, while they usually offer the lowest interest rates and the broadest repayment window, also entail closing costs, appraisal fees and loan origination fees. These can really add up. Further, in exchange for that terrific interest rate, home equity lines of credit require you to pledge your home as collateral.
You could be forced to sell your house if there’s a problem paying off the loan.
Credit card balance transfers typically come with a transfer fee of a certain percentage of the amount you bring over. They can also have annual fees and once the attractive interest rate expires, you could easily be facing double-digit APRs.
One more thing — and this is pretty huge — once all of your debts are rolled into one loan, the accounts from which those funds were transferred will reflect zero balances. Having unused credit just sitting there has enticed more than a few otherwise rational human beings into running accounts up to their limits again.
Except for this time, in addition to all of those cards, that consolidation loan is still hungry too.
So, Which Is Better, Debt Consolidation or Debt Management?
You probably saw this response coming from a mile away.
The answer is — it depends.
Both methods are viable. However, both require a strong sense of discipline too. If your credit score is strong and you can resist using cards without being forced to do so, consolidation is a strong option — assuming the numbers work out in your favour.
If your credit score is softer, management can be a good move, plus you’ll have a counsellor watching your back. And, if you decide you’d like to pursue a different approach, you can get out of a management program a lot easier than you can walk away from a consolidation loan.