After a significant period of belt tightening following the Great Recession, Americans have once again amassed a worrisome amount of debt. Eighty percent of Americans are in debt, with 39 percent in credit card debt, according to a July 2015 report by the Pew Charitable Trusts.
The average U.S. credit card holder owes $7,789 in unpaid credit card debt, according to a March 2016 study from CardHub.com. The study also showed that Americans amassed $71 billion in credit card debt in 2015 alone. U.S. financial consumers are falling into toxic debt in other key areas, as well. According to the New York Federal Reserve, total auto loan and student loans stand above $1 trillion.
Debt-straddled consumers looking for a way out have several paths to debt reduction; two of the most common personal debt management strategies are debt consolidation and debt restructuring. Although these two strategies both aim to ease consumer debt burdens, their executions are distinctly different. Learn the details of debt consolidation and debt restructuring to understand how each can be an effective tool for Americans fighting debt problems -- and when it's best to use one over the other.
Read: 6 Strategies to Get Out of Debt
What is debt consolidation?
Debt consolidation is a straightforward process in which multiple unsecured debts -- such as debt from credit cards, personal loans, and medical bills -- are combined into one bill and paid off together with a single loan. Debt consolidation is a long-term financial strategy.
"Debt consolidation refers to paying off more expensive debt using cheaper debt," said Jerry Gupta, chief executive officer at FundTerra.com, a next-generation real estate brokerage firm based in Boston, Mass. "As an example, I paid off my expensive student loans by refinancing my house, thereby getting a cheaper rate."
Three major types of debt consolidation exist:
Debt management plans: An organization -- preferably a non-profit -- helps you get lower interest rates or waived fees from creditors to make your monthly payment affordable. You make one payment to the organization, who breaks up the amount and sends payments to all your creditors.
Debt consolidation loans: You make one payment to one lender. Generally, this loan should have a lower, fixed interest rate than your original interest rates. Home equity loans, zero-interest balance transfers on credit cards and personal loans are examples of this type of loan.
Debt settlement: An organization negotiates a lump-sum payment with each of your creditors for less than what you actually owe. Debt settlement is not usually recommended, because many creditors will not agree to it and because it will significantly and negatively impact your credit score.
"Debt consolidation is just what it sounds like," said Dr. Roy Teel, a former debt collection specialist with 30 years in the industry. "The person or business in this case has sufficient credit available to take out a consolidation loan. That could be an advance on a low-interest credit card for smaller amounts of debt, or, for larger amounts of debt, it could mean a line of credit based on tangible assets such as a home or cash they have on hand in investment, like a 401k plan or IRA savings account."
What is debt restructuring?
Some debt management experts say there is confusion between the terms debt consolidation and debt restructuring, and many financial consumers view them interchangeably. "However, from a technical finance perspective the two are very different," said Gupta.
"Restructuring is a situation where the borrower and lender negotiate different terms," Gupta said. "This is usually under threat of bankruptcy where the lender feels he or she may get more money back be renegotiating as opposed to letting it go to bankruptcy."
Debt restructuring programs are generally geared toward more severe cases of personal or business debt. It's mostly applied in bankruptcy situations, Teel said.
"While it's usually applied in either a Chapter 13 bankruptcy for individuals or Chapter 11 bankruptcies for businesses, debt restructuring is more for businesses than it is for individuals," Teel said. "A good attorney is almost always required in a debt restructuring deal."
Pros and Cons: Debt Consolidation
If you have debts, have used a debt consolidation calculator and found that debt consolidation could be a solution for you, it's important to consider all sides of this strategy. Take a look at the pros and cons of debt consolidation to better understand this debt management tool.
Pros of Debt Consolidation: Simplified Debt Payment and Better Credit Scores
By consolidating debt, you are essentially taking multiple lines of credit and payments and creating a single payment that will eventually pay down all your debts under a single loan. Aside from making paying off debts simpler, there are a few other major advantages to debt consolidation:
Lower interest: Usually, interest rates on your consolidated payment are lower than the interest rates of credit cards and other debts.
Credit score boost: As long as you pay on time, a debt consolidation loan will increase your credit score because in the eyes of creditors, you'll have improved your financial situation because you've minimized your debts to just one loan. "Just make sure that you get it in writing from any creditor, lender or debt collection agency that the account repaid will be reported as paid," said Teel.
Abundant online options: In consumer finance, personal loans designed to help people pay off debt -- particularly credit card debt -- have emerged in recent years," said Kevin Gallegos, vice president of operations with Freedom Financial Network. "Several private companies now offer personal loans as a means of refinancing credit card debt primarily into a fixed, amortizing installment loan. Some of the main new independent lenders, often known as peer-to-peer lenders, include FreedomPlus, Prosper and Lending Club."
Cons of Debt Consolidation: High Fees and More
Debt consolidation isn't just a single easy payment with low interest rates; there are a few key disadvantages to consider, too. If you want to consolidate credit card debt or other unsecured debt, you should understand the negative aspects of this debt management tool:
Bogus debt consolidation programs: Professional debt consolidation services can be one answer for how to consolidate credit card debt, but Teel said that consumers should watch out for unethical debt consolidation companies that promise more than they deliver. "The best companies will put you on a budget, based on the financial information you provide, pull money out of your bank account every month, and gradually repay your debts," Teel said. "But some of these companies are frauds, and will steal your money and not pay your bills."
High debt management fees: Some services have high fees, and many rely on loans secured by personal property, like a home or car. "If you can't make the payments, you risk losing those valuable items," Gallegos said.
No quick fix: If you don't make your payments, you're back where you started. If you sign off on a debt consolidation plan and don't keep up, you're back to square one -- with even more fees and penalties.
Read: Best Low-Interest Credit Cards
Pros and Cons: Debt Restructuring
To better understand how debt restructuring can help manage debt effectively, consider the advantages and disadvantages of this method.
Pros of Debt Restructuring: Reduced Interest and More
Debt restructuring offers important advantages that make it the right solution for some debt holders:
A more-structured agreement: In many cases, you can work out an agreement in bankruptcy to repay your secured creditors, mortgage holder, auto loan and other debt that is secured by assets. Through debt restructuring, you make smaller payments or even get some debt forgiveness; at the same time you can eliminate unsecured debt such as credit card debt.
Bundled payments: With debt restructuring, your loans and debts are consolidated into a single monthly payment, Gallegos said.
Reduced interest: In many cases, the amount of interest owed is reduced dramatically, or even eliminated.
Cons of Debt Restructuring: Negative Tax Impact and More
Although debt restructuring might seem like an easy answer in some financial situations, this method of debt management does have some negative features that should be considered:
Negative Tax impact: Debt consolidation rarely results in a taxable event but debt restructuring might, said Gerri Detweiler, a personal finance expert and head of market education for Nav, which provides free business and personal credit scores. "Debt consolidation is simply replacing one loan with another and you don't owe taxes on that," Detweiler said. "But if a creditor restructures a debt and forgives more than $600 of the balance, the creditor is required to file a 1099-C with the IRS, reporting that cancellation of indebtedness income."
Ties your hands financially, and for a long time: Debt restructuring through bankruptcy remains on your credit for 10 years, and will severely impact your ability to borrow money in the future, said Teel. "It also can have negative impacts on your ability to get a job or even impact your current job," Teel said.
Student loan debt not included: Student loan debt is not discharged in a debt restructuring bankruptcy situation, Teel said. "You may be able to negotiate better terms but you are most likely going to have to pay off all of your student loans, just over an extended period of time."
Three Questions to Ask a Financial Advisor Before Making Any Debt Deals
Consumers looking to slash debt burdens should make a list of questions to ask a financial advisor to better help them decide between debt consolidation and debt restructuring, or to avoid using either option. To build the best list, start by asking these three questions:
How much money could I potentially save by restructuring or consolidating debt?
What happens if I don't keep up with my debt payments?
Given my present debt situation, which option -- debt consolidation or debt restructuring -- makes better sense for me, and why?
Nobody ever wants to find themselves in a deep financial hole. But if that's your debt situation and it's overwhelming you, talk to a trusted financial services professional and see if either debt consolidation or debt restructuring works for you.
Debt consolidation or restructuring might be an unfortunate necessity, but either option could wind up saving you from a sea of debt, and years of stress and worry over the problem.
Read: 8 Ways to Bounce Back From a Financial Setback
This article originally appeared on GOBankingRates.com: Is Debt Consolidation the Same as Restructuring Debt?