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. Even if you proactively seek solutions, finding a solution to becoming debt-free can be difficult. And because everyone’s financial situation is different, there’s no one-size-fits-all answer.
Credit counseling agencies offer debt management plans (DMPs)—a type of debt management program that could be helpful if you’re struggling with credit card debt, but there is a lot to consider before you sign-up.
What Is a Debt Management Plan?
A debt management plan works like this: Acting as your agent, a counseling coordinator contacts your creditors, explains your debt repayment struggles, and attempts to negotiate more favorable terms for you.
Every creditor willing to participate negotiates its own terms. The credit counseling agency then 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 agency, and they distribute it to your creditors until your debts are paid in full. Some plans include smaller monthly payments, lower interest rates, or waive penalties so you can get caught up.
Debt management plans, or DMPs, are generally for people who have unsecured debts, such as credit card debt. There’s no credit score requirement, which can make them a good fit for those receiving collection calls or who have less-than-stellar credit. However, secured debts—like your mortgage or auto loan—can’t be included.
Debt Management Plan vs. Debt Settlement Program
Debt management plans are sometimes confused with debt settlement programs, but they’re very different approaches to tackling debt. Debt management plans are intended to 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. It may seem like a good option, but debt settlement can be costly as most debt settlement companies charge a fee for this service.
You may also be advised to stop paying your debts in order to make creditors more likely to accept a settlement offer. In the meantime, you could have to set aside money for your settlement offers and pay fees to a third-party company that holds the money in a locked account.
Keep in mind, it could be years before settlements are arranged and your accounts could continue accruing interest and fees. If you aren’t making on-time payments, your credit score could also take a hit.
While debt settlement might work at times, there’s no guarantee a creditor will accept a settlement offer. Some people wind up leaving the program with worse credit and higher balances. You may even risk getting sued by the creditors and having money taken out of your wages or bank account.
What You Should Know About Debt Management Plans
While DMPs can be helpful in certain circumstances, they’re not the best option for everyone.
DMPs aren’t for every type of debt.
DMPs are primarily for unsecured debts, particularly credit card debt. If you’re struggling with a secured loan or certain types of unsecured debts (such as student loans or tax debt), you may need to look for different payment plans or options.
There are no guarantees.
While credit counselors may try to negotiate on your behalf, credit card companies and other creditors don’t have to agree to concessions or participate in a DMP. You’ll remain responsible for managing the accounts that aren’t part of the DMP.
You may have less access to credit.
As part of the agreement, you might be forbidden from opening or using credit cards until you’ve completed the DMP. Although, depending on the situation, the counseling agency might let you keep one card for emergencies.
You’re in it for the long haul.
A DMP might take three to five years to complete.If you drop out early you’ll still owe the included debts, but your creditors might end concessions the credit counselor was able to secure, such as a lower interest rate.
Your credit score could take an initial hit.
A DMP often requires you to close your credit cards, which could hurt your credit scores by changing your credit mix and increasing your credit utilization ratio. But if you follow through and are able to make your payments on time, you may see your credit scores rise as your debts are paid off.
Your credit report may also show that you’re working with a financial counselor when you sign up for a DMP. Lenders reviewing your credit reports will see this information, but it won’t impact your credit scores.
You have to find a good credit counselor.
Many nonprofit credit counseling agencies offer different types of counseling services, advice, and debt relief options. However, they don’t necessarily all have the same level of expertise or service.
You can look for reviews of credit counseling agencies online and through the Better Business Bureau. You could even interview several to get a feel for the differences (many offer a free initial consultation).
It may also make sense to narrow your search to agencies that have certified credit counselors and are part of an accredited association, such as the National Foundation for Credit Counseling (NFCC).
A debt management plan isn’t your only option.
You may also want to work with a credit counselor who discusses the pros and cons of different options rather than solely pushing a DMP. Some people may find other options that make more sense based on their finances and goals.
For example, you may be able to revise your budget and afford the payments without having to close your accounts or work with an intermediary. Or, you might find it makes more sense to combine your debts and lower your interest rate with a debt consolidation loan.
As a last resort, if you can’t see any way to afford payments moving forward, bankruptcy could be worth considering.
The Bottom Line
If you’re struggling with paying your credit card bills or other unsecured debt, a debt management plan might offer you the help you need to get back on track. Debt management plans lumps your payments into a single payment and can help cut your interest rates while providing you a structured path towards financial freedom.
However, it’s not for everyone. If you enroll in a debt management plan, you may have less access to credit, and your credit score might take an initial hit. Debt management plans also come at a cost, as most credit counselors charge a fee for their services.
Debt Management Plan FAQs
Still have questions? Some of these commonly asked questions may provide the answer.
1. Do debt management plans hurt your credit?
Signing up for a DMP doesn’t directly impact your credit score, but your credit might take a slight hit while you work on your debt management plan.
You may need to close your credit card accounts which could limit the mix of open accounts types on your credit reports and increase your credit utilization rate, which could hurt your credit score.
2. Is a debt management plan a good idea?
Debt management plans can be a good idea if you’re consistently paying down your priority loans (like a mortgage), but are struggling to keep up with your credit card debt. It will allow you to make smaller monthly payments to improve your cash flow, lowering your interest rate so your debt stops mounting up so fast.
3. What are the disadvantages of a debt management plan?
Debt management plans may require an upfront and monthly fee, they won’t help you with secured debts, and they can require you to close your credit cards. There’s also no guarantee that creditors will agree to participate, and you’ll have to trust that the credit counselor will pay your creditors on time.
4. How long do debt management plans last?
Most DMPs are intended to pay off the included debts within three to five years. You may have a fixed monthly payment during the repayment period. As you pay off one account, the counseling agency will take the money and apply it to the other outstanding accounts.
5. What is the best way to manage debt?
There’s no overall best approach to managing debt as everyone’s situation and debt are different. If you want to pay off debt quickly, consider listing your debts and making a plan for which ones to tackle first. Sometimes using another resource, such as a DMP or debt consolidation loan, can be helpful.
6. What does a debt management program do?
Debt management programs may offer different approaches to paying off debts. Some are guidelines or strategies, such as the debt avalanche and snowball methods. Others require working with a third-party, such as a credit counselor, or with a new creditor to consolidate and refinance your debt.
7. What is the best way to manage debt?
The best debt management program may depend on your financial circumstances and credit. Bankruptcy might be the best option for some. Others may benefit from a DMP, or even from debt settlement. For some, a debt consolidation loan could be the best way to save money and get lower monthly payments.