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Debt consolidation loans vs. debt consolidation programs: What's the difference?

Debt consolidation loans and services are different products that serve different purposes. Getty Images

The majority of adult Americans have at least one credit card in their wallets — whether they're using it for rewards, convenience, large purchases or as a daily payment method. But while credit card use is common, it's worth noting that credit cards tend to have high interest rates, and that can cause credit card debt to add up quickly. 

If you're facing overwhelming amounts of credit card debt, you may be considering solutions like debt consolidation. But when it comes to debt consolidation, there are a couple of ways in which the process can work. For example, debt consolidation may mean getting a new loan at a lower rate to pay off what you owe — or it could be part of a program led by debt relief experts

So, what are the differences between the two? Perhaps more importantly, which option is better for you given your unique situation? By understanding how each operates you'll better be able to determine a path toward debt relief.

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Debt consolidation loans vs. debt consolidation programs: What's the difference?

"Debt consolidation loans and debt consolidation services can be important when it comes to managing finances," explains Derek Miser, investment advisor and CEO at Miser Wealth Partners in Knoxville, Tennessee. "However, there are distinct differences between both." Here's what you should know: 

What is a debt consolidation loan?

"Debt consolidation loans are used to specifically pay off debts," explains Miser. "You can combine all debts into one loan. The debt consolidation loan will typically have a lower interest rate than your current debts."

These loans don't just save you money, they can make your debts easier to manage. After all, you'll use them to consolidate multiple credit cards and personal loans into one, easy-to-manage account. The two most common types of loans consumers use to consolidate debts are: 

  1. Personal debt consolidation loans: These loans typically come with competitive interest rates when compared to credit cards and a fixed payoff plan, offering a clear path to payoff. 
  2. Home equity loans: Home equity loans may give you a way to access a significant amount of money at a competitive interest rate. As such, these loans provide a compelling way to consolidate high interest debt.   

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What is a debt consolidation program?

A debt consolidation program is a service that's offered by a debt relief company. The process typically starts with a conversation between you and a debt relief professional. That professional will usually ask you questions about your income and expenses to get an understanding of your current financial position. 

Once they have all the information they need, representatives of the debt consolidation company generally contact your credit card lenders to negotiate lower interest rates and better payoff terms on your behalf. The next step is to set up an affordable, yet effective payment plan. 

Once this process is complete, you'll start making your monthly payments to the debt consolidation company. The company will send payments to your individual lenders on your behalf until your debt is paid in full.  

Do debt consolidation loans hurt your credit score?

Debt consolidation loans don't typically have a negative impact on your credit score, but they may have a positive impact. That's because one of the factors that makes up your credit score is credit utilization. When you use a new loan to pay off your existing credit cards, your credit utilization score should improve. As such, your credit score may rise. 

Do debt consolidation programs hurt your credit score?

Debt consolidation programs may have a short-term negative impact on your credit score. That's because debt consolidation programs use your financial hardship information to negotiate better terms. As such, your lenders will usually close your accounts, which may have a negative impact on your credit utilization ratio. 

Who is a debt consolidation loan best for?

"In order to obtain a debt consolidation loan, you will have to apply, which will require a credit check," says Miser. "The terms of the loan will depend on your credit score." The best rates and terms are usually reserved for those with the best credit scores and overall applications. So, this is often a strong option if you're not falling behind on your debts but want a faster way to pay them off.

Who is a debt consolidation program best for?

Debt consolidation services use your financial hardship data to negotiate better terms on your behalf. So, these programs are typically best for borrowers who are having a hard time making their minimum payments and who don't qualify for favorable debt consolidation loan interest rates. 

The bottom line

"Choosing between debt consolidation loans or services will ultimately depend on your situation and preference when it comes to handling debt," explains Miser. He says, "you should do your research and speak with a financial professional before making a decision." 

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