While the two sound similar and in fact can both have the effect of making your debt burden easier to manage, they are quite different animals. Moreover, they carry very different consequences in terms of your credit history. Let’s take a look at debt consolidation versus debt restructuring to clear up the differences between the two.
Debt Consolidation
This is the process of combining as many of your debts as possible into a single one to make them easier (and ideally) less costly to satisfy. Basically, you’ll take out a loan capable of encompassing all of your outstanding debts and use the proceeds to pay them off. You’ll then make a single payment each month to the new lender. Done carefully, this will lower your monthly outlay, shorten the amount of time you’ll need to pay off your debt and reduce the overall amount of interest you’ll pay. In other words, managed carefully, this can be a win-win-win situation.
Debt consolidation can take a number of different forms, the most common of which are:
- Credit card balance transfers
- Home equity loans or lines of credit
- Personal loans
- Loans from a bank or credit union
- Borrowing from family or friends
- Borrowing from retirement accounts
Debt Consolidation Consequences
As we mentioned above, debt consolidation can result in lower interest payments and it can simplify the repayment process. After all, you’ll only have one debt to deal with each month instead of several. Debt consolidation, while requiring a pretty strong credit score in the first place, can also help you make your credit score even higher. On the other hand, it isn’t a quick fix, you will have to pay off the consolidation loan and best debt consolidation loans.
Further, you must address the underlying cause(s) of the problem before you do a consolidation. If you keep spending the way you did before, you’ll find yourself in an even deeper hole. Your old accounts will get charged up again and you’ll have the consolidation loan to pay off.
Debt Restructuring
Under restructuring, you’ll negotiate with your creditors to accept a revised loan agreement. Ideally, you’ll get them to lower the amount you’ll be required to repay, whether through forgiveness of a portion of the principal and/or the waiving of accrued interest and/or fees.
Restructuring is a good move to try if your financial situation has you searching phrases like, “What is Chapter 7 bankruptcy?” While it’s true both approaches will have a negative impact on your credit history, restructuring is generally easier on your credit score than filing for bankruptcy protection.
Many lenders will agree to work a restructuring plan with you because they know they could see even smaller returns in a bankruptcy settlement. After all, they’d be forced to get in line with everyone else you owe and wait to see how a judge distributes payments based upon your remaining assets.
Debt Restructuring Consequences
On the other hand though, lenders aren’t going to be very happy about accepting those revised repayment terms and they will make their disdain known to credit reporting bureaus. This means your credit score will fall even farther than it did before you were deep enough in arrears to make restructuring your debt an attractive option to your creditors in the first place.
What’s more, those forgiven dollars will be reported to the IRS as part of your income, which means you’ll pay taxes on them. Another thing to keep in mind is while consolidation can encompass pretty much all of your debt — regardless of the type — restructuring car loans and mortgages is not possible. Those lenders will simply repossess their collateral if you cannot pay.
Understanding the differences between debt consolidation and debt restructuring is critical. While the two sound similar, they are two different solutions to a similar problem — the choice of which will be dictated by your personal circumstances.
