Sky-high inflation, turbulent markets and ballooning interest rates have made life tough for consumers. To wit: Half of Americans reported that they are financially worse off now compared to last year, according to a recent Gallup poll.
Debtholders, thanks to higher borrowing costs, have had it particularly rough. If your red ink has become overwhelming, one option to consider is a debt management plan (DMP).
What is a debt management plan?
In a debt management plan (DMP), clients work with a consumer credit counseling agency to come up with a repayment plan and follow through on it.
“We also work with your creditors to lower interest rates, waive or eliminate fees and stop collection calls,” said Tayri Martinez-Orza, a quality assurance specialist at GreenPath Financial Wellness, a nonprofit financial counseling service.
If the creditor is willing to negotiate, “clients end up saving money on interest and getting out of debt sooner because more of the payment goes toward reducing the principal balance,” Martinez-Orza said.
Who would need a debt management plan?
A debt management plan is best for people who are stressed about their obligations, but aren’t yet in dire straits. If you have a pile of debt built up, are struggling to make payments and starting to fall behind, it might be for you.
“DMPs are generally best for those facing a less-severe financial hardship,” said Sean Fox, president of Achieve Debt Resolution, a personal financial services company.
If you are several months behind on all of your payments and getting regular calls from debt collectors, you might benefit from a DMP.
A debt management plan might be right for you, if:
- You have experienced a temporary hardship and need help getting things on track.
- You’re borrowing up to or near your credit limits.
- You have above-average interest rates.
- You have missed several payments.
- Your budget is out-of-whack.
- You earn enough income to make payments.
How does a debt management plan work?
Think of the DMP itself as a roadmap, crafted in consultation with a credit counselor, that will help you work down unsecured debt, such as credit cards, as cheaply and quickly as possible.
Your debt management counselor negotiates with your creditors to reduce fees and interest rates, then helps you to both create the plan and stick with it. In many cases, you’ll make one payment to the agency, which will then pay your creditors on your behalf.
“You’re making one payment that has a steady amount and interest rate across several years,” said Andrew Rosen, CFP and president of Diversified, a wealth management company headquartered in Wilmington, Del.
In most cases, you can’t open a new loan or take on more debt. In fact, the agency may close your accounts as you pay debt off, like credit cards, so that you don’t have the temptation to spend again.
You’ll need discipline to succeed. Most plans are three-to-five years long and only work if you keep up with your payments.
What are the pros and cons of a debt management plan?
Setting a goal and getting a professional on your side can help you to see a light at the end of the tunnel of debt. There is no credit check to qualify, but following through on one might not be easy.
Pros
- Pay less in interest rates and fees.
- Avoid bankruptcy and stop collection calls.
- Simplify unsecured debt into a single payment.
- Improve your credit.
Pay less in interest rates and fees
Your creditors may agree to lower rates or fees because you’ve made a concerted effort to pay them back. The debt is unsecured, after all, and they may receive less if you ultimately declare bankruptcy.
Credit counseling agencies themselves are nonprofits and typically cost much less than the for-profit businesses like lawyer firms and debt settlement companies.
Avoid bankruptcy and stop collection calls
A DMP, with a payment due each month, will hold your fee to the fire and make it less likely that you delay your debt payments and potentially fall into bankruptcy. Plus, with money being paid, your creditors may automatically stop contacting you and causing stress.
Whether you have a DMP or not, you have the right to tell a debt collector to cease communicating with you based on the Fair Debt Collection Practices Act (FDCPA).
If you are dealing with constant calls, follow these steps outlined by the Consumer Financial Protection Bureau (CFPB):
- Identify who the creditor is, including their address and phone number.
- Find out how much is owed, including any fees, interest or collection costs.
- Ask when the debt was incurred and for what purpose.
- Determine the name of the original creditor.
- Get a debt validation letter to make sure it is you, and not someone else, who owes the debt.
Simplify unsecured debt into a single payment
A streamlined, single payment on your unsecured debt can help you save money, as you’re less likely to miss a payment, incur late fees and face mounting interest. Moreover, the simplicity of dealing with one monthly payment, rather than several, will make your finances easier to manage.
(Your payments for secured debt, like your home and your car, will still likely be separate.)
Improve your credit
The largest factor used to calculate your FICO credit score is payment history (35%), followed by amounts owed (30%), length of credit history (15%), credit mix (10%) and new credit (10%).
“Making those timely payments will typically improve your credit over time,” said Martinez-Orza.
Rosen cautioned there won’t be an immediate impact on your credit; it’ll take time to see it start to inch upward. Promises of immediate credit repair is a red flag that you might be the target of a debt relief scam, not a legitimate credit counseling agency.
“Be aware that [a DMP] will not erase negative items from your credit report,” said Leslie Tayne, a New York-based debt relief lawyer. “If an agency tries to tell you otherwise, run.”
There is some nuance in how a DMP affects your credit, but working down your debt will help your score in the long term.
Cons
- It’s not debt elimination and creditors have to agree.
- Unsecured debt only.
- No new lines of credit and possible counseling fees.
- Discipline is required.
It’s not debt elimination and creditors have to agree
It’s important to note that a DMP doesn’t erase debt; you will still be paying it off. This can cause challenges if you’re not prepared.
“In many cases, consumers attempt a debt management plan, but eventually wind up filing bankruptcy because they can’t afford the payments,” said Fox.
The businesses and people you owe money to don’t have to agree to waive fees or charge less interest. In most cases, they’re under no legal obligation to work with you and have the right to refuse to accept less money.
Any DMP payment you establish needs to be affordable for you for the entire payment term, which can last five years. If this seems impossible, consider taking the bankruptcy means test to gauge if that’s a possible option.
Unsecured debt only
A DMP only applies to what you owe from credit cards, personal loans and other such unsecured debt. It doesn’t apply to things like mortgages and car loans.
If you want to lower your secured loan payments, you could look into a mortgage refinance and auto refinance. Research your options carefully as lowering payments often involves extending your loans, which can increase how much you pay in total interest.
No new lines of credit and possible counseling fees
You typically aren’t able to take out a new loan while you have a DMP.
If you apply for one, most lenders will require an approval letter from your DMP provider before they will issue credit, according to Summer Red, Accredited Financial Counselor at the Association for Financial Counseling and Planning Education.
You’ll need to maintain an emergency fund and budget accordingly. Your budget will likely need to include fees for the debt counseling agency that administers your plan.
“DMP fees vary based on your state of residence and debt amount,” said Martinez-Orza.
However, these fees are minimal considering the amount of money you can save in reduced interest charges, waived fees and in preventing future financial problems.
Discipline is required
Paying down a large amount of debt requires a commitment that can be difficult to maintain and most DMP providers do not include ongoing financial counseling as part of their program.
“Permanently reducing and/or eliminating debt requires lifestyle and spending changes, which the DMP does not address.” Said Red.
There’s no guarantee you won’t accumulate other debt, such as medical debt, which Rosen notes typically can’t be added to the plan.
Many people who get one DMP will eventually get a second.
If you decide to get a DMP, consider how you’ll keep yourself on track over the years so you can succeed. Continuing to see a credit or debt counselor can help.
How do you enroll in a debt management plan?
1. Find help
Contact a 501(c)(3), nonprofit credit counseling agency that’s accredited and licensed.
Though similar, debt management plans aren’t one-size-fits all. One counseling agency might allow you to lump student loans into your DMP, while another won’t, for example. That makes finding the right counselor among the key steps to enrolling in a plan.
You can search the National Foundation for Credit Counseling, Council of Accreditation (COA) or Financial Counseling Association of America to find one that fits your needs.
When you do contact them, ask about the fee structure and get it in writing.
“Do your due diligence before signing a contract,” said Tayne. “The agency should have few complaints, employ qualified, well-trained counselors, offer financial education alongside the debt management plan and provide services at an affordable rate.”
Even better if the agency can give you tools to manage and track your repayment progress.
2. Confirm you’re a good candidate
Sit down for a credit counseling session with a certified professional who will help to determine whether a debt management program could help.
A debt management program might not be right for you if:
- You don’t have the cash flow to afford modified repayment terms.
- You have the means to afford more than the minimum payments and could benefit from an alternative repayment method.
- Your major creditors don’t agree to participate.
- You have just one or two creditors and they’re willing to modify your repayment terms without a DMP.
3. Follow through
If you decide to move forward, be aware that your credit and loan accounts will be closed, and that borrowing while enrolled in the program isn’t advised or, in many cases, allowed.
What are the alternatives to a debt management plan?
While a DMP can be a worthwhile solution for some consumers, there are other options to consider. If a debt management plan isn’t the right course of action, you’re not out of luck.
- Use a debt payback method. To structure your finances, you can adopt a proven plan to attack debt with the snowball method.
- See if you’re eligible for hardship assistance. Many creditors and government agencies have options for people who are facing financial hardship. Open the lines of communication with your creditor to see if they will offer a repayment pause or interest rate reduction. If you recently lost your job or faced a medical emergency, for example, you might qualify for temporary relief, depending on the type of debt in question. Student loans, for example, typically have deferment and forbearance options.
- Get financial counseling. You can talk with a credit counselor and get help without signing up for a DMP.
- Do a balance transfer. Rather than keeping your credit card debt in an account that’s charging interest, transfer it to a credit card that has no interest or low interest. Here are the best 0% intro APR credit cards.
- Debt consolidation or refinancing. A common way to group your debt to pay it off more effectively (beyond balance transfer cards) is taking out a personal loan. Debt consolidation options for bad credit are more limited than if you have good credit or a cosigner.
- Consider debt settlement. If things are looking bad and your credit score is already doomed, debt settlement might have more pros than cons. If your creditor doesn’t offer relief programs or perhaps the account is already in the hands of a debt collection agency, you could attempt a debt settlement. This involves agreeing to pay less than what you owe, either via lump sum or a payment plan. Negotiating with debt collectors can be tricky, however, and might require legal assistance.
- Look at bankruptcy. If things are really bad and there’s no feasible way out of debt, bankruptcy might be the answer. Be aware though that you must qualify for it and it’s not an easy solution. Filing for bankruptcy can help you discharge debt (Chapter 7) or come up with an affordable payment plan (Chapter 13), but it’s a true last resort option that has repercussions on your credit for years to come. Before proceeding, it could be worth talking to a bankruptcy lawyer.
Frequently asked questions (FAQs)
Yes, you can work directly with your creditors to request lower interest rates and waived fees. However, credit counselors typically have a better sense of the system’s ins and outs and have established relationships with creditors, which can provide a large benefit. Plus you’d be responsible for making on-time payments to multiple creditors.
With a debt management plan you work with a trusted non-profit credit counseling agency to pay back all debt. By contrast, in a debt settlement situation, you work with a for-profit company and ultimately pay less than what you owe.
Debt settlement can severely impact your credit, you will likely owe taxes on the amount of debt that is forgiven and debt settlement companies charge fees that range from 15% to 25% of your enrolled debt.
Unsecured debts may be included in a DMP:
- Accounts in collections.
- Credit cards.
- Lines of credit.
- Medical bills.
- Past-due balances for routine monthly bills.
- Repossessions.
- Student loans.
- Unsecured personal loans.
