This is Chapter 2 of 5 in our Ultimate Guide to Debt Relief series.
If you’re struggling to pay down consumer debt, particularly from credit cards, enrolling in a debt management plan is one option for getting out of debt. As you weigh your options and evaluate your situation, you should think about the pros and cons of each and what would be the best way to move forward.
Here’s what you need to know about debt management before you enroll:
- What is a debt management plan?
- How does a debt management plan work?
- How is debt managment different from debt consolidation?
- What does debt management do to your credit?
- What happens if I stop paying my debt management plan?
- How do I choose a debt management program?
What is a debt management plan?
A debt management plan is an option for paying off debt. You can create one yourself with a budget that prioritizes paying debts. You can also enroll in a credit counseling agency’s debt management program that can make it easier to get out of debt. Sometimes having additional accountability is helpful.
“The goal of a debt management plan is to get you out of debt in the shortest period of time, without going through bankruptcy or debt settlement, both of which are detrimental to your credit score,” says Katie Ross, American Consumer Credit Counseling education and development manager.
However, a debt management plan doesn’t work for all kinds of debt.
“A debt management plan targets consumer, unsecured debt. Think credit cards and personal loans. If you have student loans or a mortgage, these won't be covered,” says Morgan Taylor, LetMeBank finance expert and CMO.
How does a debt management plan work?
If you enroll in a debt management program, the credit counseling agency will work with your creditors to negotiate interest rates and fees. This will make it easier to pay off your debt.
You’ll make a regular payment to the credit counseling agency which will then disburse it to each of your creditors. Simplifying your debt into one regular payment will make it easier to keep track of your payments.
“Credit counseling agencies are also known as debt management companies. They work by maintaining pre-arranged agreements with credit card companies; the card issuer lowers interest rates on the consumer's debt to a "concession rate" the creditor provides. With this new rate, credit counseling agencies typically then enrolls a consumer in a debt management plan (DMP). In these plans, the credit counseling firms charge consumers a monthly fee. They also receive payments (called “fair-share” payments) from the credit card issuers. Terms of payment are typically five years.
Payments are usually only slightly lower than regular minimum payments. In many cases, consumers attempt a DMP, but eventually wind up filing bankruptcy because they can’t afford the payments,” says Sean Fox Freedom Debt Relief co-president.
If you enroll in a debt management program, you’ll pay a one-time enrollment fee and have a regular administrative fee added to your regular payment. These amounts vary depending on each person’s situation, but the fees should be clearly stated before you enroll in the program.
How is debt management different from debt consolidation?
Debt consolidation typically refers to taking out a single, large loan to pay off existing debts immediately. Then, all of your debt is consolidated into one loan with one monthly payment. Resolving your debt this way is not the best solution for everyone.
“Debt consolidation can be helpful when a person has one or more accounts with high interest rates, and a lower interest rate will help them in paying off the debt. It is NOT the best solution for people who are unable to make minimum payments on current debt,” advises Fox.
Debt management programs mimic debt consolidation’s single payment for all debts without the need to apply for another loan. Debt management programs have fees, so if your choosing between the two options, compare available interest rates and loan fees with debt management fees to see which is the cheapest option.
What does debt management do to your credit?
There are two ways credit can be affected: through the credit report and the credit score.
Arguably, the largest initial impact is on your credit report.
“Initially, when you enroll in a DMP, there is a notation on your credit report, but it is usually seen as neutral, so it doesn’t hurt your score,” says Ross.
However, the notation prevents you from being approved for new lines of credit.
Debt management ultimately helps your credit score if you’re consistent with your payments. Meeting your financial obligations shows lenders that you’ll pay back the money they lend you.
“Using a debt management plan won’t impact your credit score. However, since you are freezing or closing accounts and altering your credit utilization ratio your score may change as a result. The good news is, the on-time payments for the plan will help your score and once the freezes are lifted your score can rise even more,” says Jared Weitz, United Capital Source Inc. CEO and founder.
However, there are some negative effects to your credit:
Closing credit card accounts will negatively impact your credit in the short-term because you’ll have high usage of credit with lower credit limits. If you reach a settlement and pay less than owed when closing the account, that will show up on your credit report.
However, if you make payments on time and complete the program, you’ll ultimately be in a better position financially and with your credit.
If you make late payments, that will affect your credit and be on your credit report. Take an active role to make sure that your payments are made before they are due by verifying with the credit counseling agency and credit card companies that they’ve met their obligations.
Depending on how the credit card company reacts to your enrollment in the debt management program, you could have other issues.
“Debt management would not directly affect your credit; however, if the creditors choose to continue legal escalation this will then have a negative affect.
The same as if the contractual terms are breached as the debt management offer is not acceptable, the creditor can issue a default,” says Ash Farrer, iwoca collections manager.
Talk with your credit counselor to learn more about the credit companies they work with and the likelihood that you’ll be approved.
How long does debt management stay on your credit report?
The freeze on your credit is not permanent. Once you exit or finish the debt management program, the note is removed from your credit.
However, late payments and closed accounts will stay on your credit report. Ask your credit counseling agency about their timeliness with payments and for more details on how a debt management plan would affect your credit in the long-run.
What happens if I stop paying my debt management plan?
If you stop paying your debt management plan, you won’t make further progress on your path to being debt-free.
A few other results of stopping payments include:
- Automatic disenrollment — “If you stop paying, after a certain amount of time, you will be automatically removed from the program,” says Ross.
- Collections — “If you stop paying the debt management plan, the creditors would be notified that it has failed and the creditors would then look to continue the normal practice and collections process,” says Farrer.
If other unexpected financial challenges arise that make it difficult to maintain the debt management program, talk with your credit counselor to explore your options.
You can also disenroll yourself, especially if you are going to pursue other options.
“You can cancel or otherwise get out of a debt management plan, but that doesn’t get rid of your debt. The process for getting out of a debt management plan may vary depending on the agency you work with. Be sure to read your contract before entering into any agreement, so that you understand any possible downsides or fees,” says Greg Mahnken, Credit Card Insider credit industry analyst.
How should I choose a debt management program?
Before you enroll in a debt management program, be sure that the company and the counselor you work with are trustworthy and qualified.
Experts say to look for the following factors before working with a company:
Greg Mahnken, Credit Card Insider credit industry analyst
“Watch out for companies that feel pushy or take a long time to get back to you. You are trusting this agency to make payments on your behalf, so you should get a good feeling that they are organized and on top of your case.”
Interest in your case
Jared Weitz, United Capital Source Inc. CEO and founder
“Make sure you find a counselor that is a good fit for you, as you will be working with this person to manage your finances. The last thing you want is someone that you don’t connect with and stares at their watch more than your finances during a meeting.”
Mike Weaver, Money Ladder
“What should people consider when choosing a debt management plan? A company they know, can identify with, and can understand. Most importantly, a debt management plan should be structured in such a way that customers don’t have to enroll into a debt program, again and again. Whatever plan they choose to tackle their debt with, they should re-enter the world of good credit having learned everything they need to never return to our services.
In our playbook, the ultimate red flag would be a company that doesn’t aim to heal your faulty processes, but uses predatory practices to gain your repeat business by making sure your debt is never fully resolved. At Money Ladder, we are a member of the American Fair Credit Counsel (AFCC), and we are certified with IAPDA."
Katie Ross, American Consumer Credit Counseling education and development manager
“What should people consider when choosing a debt management program? Look for a credit counseling agency that is licensed in your state and has nonprofit status, ideally one that has been in business for a long time and is in good standing with the Better Business Bureau. It should also be a member of either the NFCC or the AICCCA, and all the counselors that assist you in the debt management program should be certified."
Morgan Taylor, LetMeBank Finance Expert and CMO
“If you're looking for debt management, look for a non-profit ideally. They'll review your situation, then offer several options for you. If someone is pressuring you to sign up for debt management same day without providing alternatives, they probably aren't trustworthy.”
Jared Weitz, United Capital Source Inc. CEO and founder
“Research the agency you are considering before signing any paperwork. If they ask for a monthly maintenance fee, application fee or a large upfront fee that may be called a “voluntary contribution”, proceed with caution. Although they may be a nonprofit, consider where your money is going.”
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