What is a Debt Management Plan?
If you’ve missed payments and creditors are calling, you may be feeling like you’re drowning and desperate for a lifeline. Could a debt management plan (often confused with a debt settlement program) through a credit counseling agency offer you some relief? When you’ve got serious debt, exploring and comparing your options is critical to ensuring you don’t make your situation worse.
What is a debt management plan?
A debt management plan, or DMP, is an agreement you make with a credit counseling agency. It works like this: A counseling coordinator, acting as your agent, contacts your creditors, explains your payment struggles, and attempts to negotiate more favorable terms for you.
Every creditor willing to participate in the debt management program negotiates its own terms. The credit counseling agency combines the offers into a single plan, with a single monthly payment. Qualified credit counselors work with you to make sure the payment fits your budget.
You make your monthly payment to the credit counseling agency, and they distribute it to your creditors until your debts are paid in full.
Typical terms of debt management plans include letting you make smaller monthly payments to improve your cash flow, lowering your interest rate so your debts stop mounting so fast, or waiving penalty fees.
Your credit will take a hit while you work the plan, and you’ll have to give up your credit cards. (Some debt management programs allow you to keep one card for emergencies.) But you’ll be on your way to restoring your financial health.
Don’t confuse a debt management plan with a debt settlement program
Debt management plans are intended give you some breathing room while you pay back what you owe. With a debt settlement program, you negotiate debt forgiveness. This means your creditor agrees to accept less than the amount you owe—usually about 50 to 80 percent less.
Sure, it sounds great, but debt settlement programs are risky: It can take a long time to reach a settlement. You usually have to pay the renegotiated balance quickly and in a lump sum. You may have to pay income tax on the amount forgiven. And settling your debt is worse for your credit score than entering a debt management plan. Creditors who settle with you typically close your accounts. Other lenders may regard you as a bad credit risk.
> Caution: Some companies (and nonprofit agencies) will negotiate settlements on your behalf in exchange for a fee or commission. Beware. Debt settlement companies often charge hefty fees or commissions. Many of them have hidden charges, such as fees for a bank account where they require you to deposit your settlement payments.
Some debt settlement companies encourage risky moves like stopping payments, to make the creditors more likely to settle for fear you won’t pay at all. But creditors have no obligation to negotiate with you or your representative. Stop paying, and they may simply continue to add interest and penalties to your balance, leaving you in even more debt.
Know what you’re getting into
Debt management plans can offer relief when creditors won’t stop calling and you’re overwhelmed with debt. But keep in mind:
1. Debt management plans aren’t right for everyone.A DMP works best if the majority of your balances are in unsecured debt (i.e., credit/charge cards, personal loans, and, sometimes, collection accounts), and you don’t have much cash left over after meeting your basic living expenses. A DMP won’t help if most of your liabilities fall into other types of debt, such as unpaid child support or tax debt.
2. You still have to pay back all your debt.A DMP helps you stop accumulating debt from high interest and penalty fees, but you’re still responsible for the full amount you owe when you start the program.
3. There are no guarantees.Your creditors may agree that it’s in their best interest to work with you through a debt management plan, but they have no obligation to negotiate with you or your representative.
4. You’re in it for the long haul.Completing a debt management plan generally takes three to five years.
5. You’ll need to commit.By signing up for a DMP, you are agreeing to stick with it until you complete the program. If you bail early, all bets are off when it comes to the negotiated agreements with your creditors.
6. Your credit score will take a hit.Participating in a DMP will hurt your credit score. However, the damage is minor compared to some other debt relief options available. In the long run, a DMP can help you put your debts behind you and rebuild your credit.
7. Kiss your credit cards goodbye.In most cases, one condition of the DMP is that you shut down your credit cards and agree not to apply for new ones while you’re in the program. However, some DMPs allow you one card for emergency use.
8. Not all DMP coordinators are created alike.Do your homework before choosing an organization to handle your debt management plan. Look for a non-profit credit counseling agency that is certified by either the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA). Choose an agency that gets great customer reviews and offers strong online or in-person consumer education and support.
9. A DMP isn’t your only option.A different approach to tackling your debt may be more suitable to your circumstances. Qualified credit counselors will lay out your options and help you decide if a debt management program is your best choice.
Agreeing to a DMP is a massive commitment, so before you sign on the dotted line, make sure you understand all of your other options. For example:
- Ask creditors to reduce your APR. The financial analysts at CreditCards.com note your likelihood of success is surprisingly high. Try this script to boost your odds.
- Tap credit card hardship programs. Most credit card companies offer (but do not advertise) help for customers struggling with their payments.
- Consolidate your debt. A fixed-rate credit card consolidation loan that helps you pay down your creditors directly may provide the relief you need to break the cycle of revolving debt.
- If paying your debt is simply beyond your means, bankruptcy is available as a last resort. Bankruptcy tanks your credit and stays on your record for up to 10 years. It won’t help with certain types of debt, notably student loans.
Every situation is unique. Seek out the advice of a trained credit counselor to assess your finances and guide you in choosing your ideal path out of debt. If it turns out, a debt management plan is the best option for your situation, be sure to choose a company that’s on your side.