Debt management plans have been proven to be an effective means of paying off high-interest debt, such as credit card bills— without having to take out a consolidation loan or file for bankruptcy protection. Typically offered by credit counseling organizations, a debt management plan can help you lower your interest rates, monthly payments and repay your debts more quickly.
What is a debt management plan?
A debt management plan is set up and administered by a credit counseling agency. Essentially, it is a structured repayment approach to eliminating unsecured debts. These include credit card obligations, personal loans, medical bills and the like.
Here, it is important to make a distinction between secured debt and unsecured debt. Secured debt is backed by some form of collateral, such as an auto loan or a mortgage. The lender can take possession of the collateral as a substitute for payment if you default on the loan. Secured loans tend to come with lower rates than unsecured loans since the lender is taking less risk of receiving nothing if the loan goes unpaid.
During your initial consultation (usually offered free of charge) a counselor will review your financial situation and look for ways to help you manage and pay off your debts. It may just be a matter of restructuring your household budget to free up money to stay on top of your bills. Credit counselors also offer financial education and assistance to help you manage your finances in a better way.
How debt management plans work
If you enroll in a management plan, the counselor will contact each of your creditors to inform them of your business relationship. With your approval, the counselor will make themselves the payer on your accounts and seek interest rate reductions for more affordable monthly payments.
The counselor will explain how much you’ll need to spend each month to pay off the rest of the debt. They will only make deals they know your income and expenses will permit you to handle. Going forward, you will send that money to your counselor, who will divide it among your creditors on your behalf. You’ll get a report each month outlining your progress.
While enrolled in the plan, you’ll agree to refrain from using your credit accounts, as well as opening new ones. Some plans require you to close certain accounts altogether. The whole point is to pay off your debts, so any actions countering that effort are to be avoided. In exchange for the concessions your creditors make, you’ll be expected to make your monthly payments on time and stick with the plan until all of the included debts are paid off. Missed payments could result in the cancellation of your plan altogether.
Debt management vs bankruptcy
The key difference between a debt management plan and filing for bankruptcy protection is, that you repay the principal loan amount and a reduced amount of interest with a debt management plan. In most cases, creditors will consider these debts paid in good standing and your credit score could improve as a result.
In most cases, creditors are not paid when borrowers file for bankruptcy protection. In this instance, they will usually report lack of payment to the credit bureaus. This, in turn, will result in a rather significant drop in your credit score. Moreover, a bankruptcy filing can stay on your credit report for up to 10 years. This could make it difficult to qualify for a loan, and if you do get approved it will be at a much higher rate. A bankruptcy filing could also prevent you from landing a job if the employment you seek requires security clearances.
Debt management and your credit score
With that said, there is one aspect of the debt management process that could have a detrimental effect on your credit score. Closing credit accounts, if required, may increase your credit utilization ratio. This can cause a dip in your credit score.
Creditors prefer to see borrowers use no more than 30 percent of the credit available to them. Closing an account means the credit associated with that account is no longer available to you, which can cause your utilization ratio to exceed that mark.
On the other hand, bringing your debts current will have a positive impact on your credit score. Should a counselor be successful in getting a creditor to re-age your past due accounts, they will be listed as “current” and your credit score could improve as a result.
Pros & cons of debt management plans
The key benefits of entering a debt management plan include professional financial advice, as well as potential fee waivers and interest rate reductions. This means your debts will be paid off sooner than if you tried going it alone.
You’ll also only have one monthly payment to make instead of several with various lenders and varying interest rates. Your accounts will be brought current too, which can help improve your credit score. Plus, debt management will put a stop to those pesky collections calls.
As outlined above, debt management plans only work for certain types of debt. Secured loans and government-backed student loan debt will still need to be handled on your own.
Debt management counselors charge a fee for their services. Setup fees can cost as much as $50 and your monthly participation fee can be as much as $75. The amounts vary, so be sure to ask before you sign up.
You’ll also need to agree to limit your use of credit cards to emergency situations. Most plans require you to stop charging altogether. Some may even insist you close certain accounts.
Is debt management right for you?
If you are struggling to figure out how you’re going to deal with a seemingly insurmountable pile of credit card debt, you might benefit from debt management. If you’re getting calls from debt collectors about credit card debt, personal loans and medical debt, debt management can put a stop to the aggravation.
There’s one more thing to consider before you enter a debt management program.
What threw your finances off track in the first place?
Maybe you lost a job or had huge medical bills that threw you for a loop. That type of debt is outside of your control. But if you spent more than you could afford, that is another story. You’ll need to adjust your spending habits if you never want to find yourself in this situation again.
If debt management doesn’t resonate with you, National Debt Relief can take you through a few other options to pay off your debt. Once you become debt free, a debt coach will share tips and tricks on how to spend wisely and achieve the life you want.