Debt Consolidation vs. Credit Counseling: What's the Difference?

When escaping the country and hiding from the law are your best ideas for dealing with debt, you know you’re in trouble. Pamela has gone through “a few bad years,” she says. Hurricane Katrina hitting her Gulf Coast community followed by a series of low-paid jobs left her with almost $60,000 in debt.

Pamela has explored debt consolidation, but doesn’t like what she discovered.

“I’d have to pay close to $900 a month for ten months,” a reader using the name “Pamela” wrote recently in response to a Credit.com story. I can’t afford that, first of all, and second, there’s no guarantee my future payments would be affordable, either.”

As a 54-year-old social worker, Pamela feels she’s running out of options. The way she sees it, her choices look pretty stark.

“I think about leaving the country every single day,” she says. “The only ways out of this are death, unemployment or becoming a fugitive.”

Pamela looked into debt consolidation, which involves getting a new loan to pay off multiple debts, explains Gerri Detweiler, Credit.com’s consumer credit expert. “For that to make sense, it has to be a lower interest rate than what they’re paying now, and there can’t be a lot of fees associated with it,” Detweiler says.

That combination can be hard to find, especially for someone with a damaged credit score. “The more you need it, the harder it is to find,” says Detweiler.

So Pamela was probably right to walk away. But there might be another option, besides running off to the Mexican desert. It’s called credit counseling. This is often done by nonprofit organizations, which help consumers rein in spending and better manage their finances. First, most credit counselors offer a service where consumers pay their bills in one large check, and the counseling agency takes responsibility for making sure that each creditor gets paid.

Also important for people in Pamela’s situation is that credit counseling groups often can negotiate with major lenders to win lower interest payments, says Barry Paperno, a credit expert and Credit.com’s community director. That can take many forms, including a permanent lowering of the loan’s interest rate, or a grace period during which no interest is charged. “The consumer counseling agencies have arrangements with various banks and lenders where they will make certain adjustments” to loans, Paperno says.

Finally, after the grace period ends or the interest rates reset, most deals brokered by credit counseling agencies reset the debts involved to “current” status. This removes the “late” warning from the account. The fact that the bill was late, however, will remain on the consumer’s credit report for years to come.

Of course, debt consolidation and credit counseling can also work hand-in-hand. Once counseling helps a consumer get her finances under control, and starts nudging her credit score up, consolidation could help her win a better interest rate and start saving money.

“Debt consolidation could be the result of debt counseling,” Paperno says. “It starts with sitting down and establishing a budget and looking at what you can afford.”

Image: meddygarnet, via Flickr