Debt negotiation (sometimes called debt settlement)

This is a technique in which the debt management or debt counseling service works with your creditors to resolve a pay back amount. Usually this amount is less than what you owe when you add interest charges to the principal. In fact, some creditors are willing to engage in debt negotiation because by the time you are at that point, you have likely already at least enough money to equal the entire original amount you borrowed.

Here is a run down of how debt negotiation works:

1. You contact the company and decide to use their services.
2. You authorize the company to act for you with regard to your debt. This means creditors no longer contact you, but go through the service as an intermediary.
3. You stop paying your creditors. Instead, you make payments to an escrow account or some other savings account set up with the debt management or debt counseling service.
4. As you stop paying your creditors, the debt negotiations on your behalf take place. Each creditor is contacted and negotiated on an individual basis. Since you are no longer paying, the service has some leverage.
5. Your creditors eventually agree to settle the debt. The debt management or debt counseling service uses the money you have been putting into the account to pay the amounts settled upon.

Debt negotiation can have a negative impact on your credit score. This is because you aren't making payments. At all. However, after you have successfully had your debt settled, your credit score will start to recover.

Debt consolidation

Debt consolidation, on the other hand, is when your debts are lumped together somehow for easier payment. Debt consolidation usually results in only one payment, rather than several, each month, as well as a lower interest rate. Debt consolidation comes in one of two forms:

Regular debt consolidation. In this form of debt consolidation, the debt management or debt counseling company finds out all of your debts and then works out a payment plan. You make one payment to the service each month, which then makes payments to each of your creditors. It can take up to two billing cycles for this type of debt consolidation to take effect, so you need to be careful about when you stop making payments to your creditors.
Debt consolidation loan. With a debt consolidation loan, you take out one large loan and use it to pay off all of your smaller loans. If you use your home equity to do this, it is possible that your interest is tax deductible. However, it is risky to tie your home to credit card debt; if you default, you could go into foreclosure.

Both forms of debt consolidation can result in an initial negative impact on your credit score. However, many people find debt consolidation preferable to debt negotiation, since it has a smaller impact on your credit score.

Choosing a debt management service

Understand that debt management and debt counseling services are businesses. Even "non-profit" services aim to make money. It is important to carefully consider your options. Some charge high rates for serve and ask for "application," "administration," "monthly service," and other fees. You also have to beware of scams, in which companies take your money but do not follow through on their end of the deal.

Compare debt management services by considering these factors:

• Minimum amount of debt needed to qualify for services.
• What method is used to determine monthly payment?
• How does the debt repayment to your creditors work?
• What kinds of debts qualify for the plan offered?
• What happens if you cannot make payments to the debt repayment plan?
• What privacy policy does the company have in place?
• Are you notified when creditors get their payments?
• Can you access your account information and status reports easily?

An alternative to signing up with a debt management service is to meet with a fee-based financial planner to help you put together a debt reduction plan.