Pros And Cons Of Debt Management

When debt repayment is a struggle, enrolling in a debt management program is one possible fix.

Debt management plans, or DMPs, can combine multiple debt payments into one so they’re easier to pay off. Other benefits may include interest rate reductions or fee waivers.

While debt management could help you get out of debt faster and with fewer headaches, it’s important to consider the pros and cons first.

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What Is Debt Management?

In simple terms, debt management is a structured plan for paying off unsecured debt, such as credit cards.

Someone who feels overwhelmed by their debts may seek out a debt management company or a credit counseling agency to get help with repaying what they owe. The debt management company or credit counselor will review their financial situation and then work with the debtor and their creditors to create a debt management plan.

Debt management plans typically allow anywhere from three to five years to repay debts included in the plan. As part of the plan, creditors may agree to reduce interest rates and reduce or waive certain fees.

Once everyone involved agrees to a DMP, the debtor makes one payment to the debt management company or credit counselor each month. That payment is then distributed among the creditors included in the debt management plan.

Debt management may be an option if you have unsecured debts that you need help getting a handle on. The types of debt you may be able to pay off through a debt management program include:

• Credit cards
• Medical bills
• Personal loans or lines of credit

In exchange for helping you with your debt, the debt management company or credit counseling agency may charge a fee for their services. This can include an initial DMP setup or enrollment fee, as well as a monthly fee. The monthly fee may be included in the amount you pay toward your debt management plan monthly. In some instances of hardship, these fees may be reduced or waived.

Debt Management Plan Pros

There are several advantages to using debt management to pay off unsecured debt. Some of the benefits include:

• Streamlined payments. Debt management plans can simplify payments, since you’ll just have one payment to make each month versus paying multiple creditors.
• Save money. If your debt management plan includes interest rate reductions and fee waivers, that could help you save a decent amount of money.
• Save time. Enrolling in a debt management program can also be a time-saver if you’re able to repay your debt at a faster pace. And you have the predictability of knowing when your debt will be paid off.

Debt management can also help you avoid potentially negative consequences if you’re in danger of falling behind on payments. Missed or late debt payments can trigger late fees, adding to what you owe. They can also result in credit score damage, making it more difficult to get approved for new loans or lines of credit.

Signing up for a debt management program can also help you head off collection actions. In a worst-case scenario, you could be sued for unpaid debts. But debt management can make it easier to keep your accounts current.

Debt Management Plan Cons

While debt management has some advantages, it’s not necessarily a perfect solution for paying off debt. Here are some of the biggest pitfalls to be aware of:

• Limited to certain types of debt. A debt management plan is generally meant to be used for unsecured debts like credit cards or personal loans. You generally can’t use debt management for car loans or other secured debts.
• Creditors may not agree. A key part of your success with debt management hinges on your creditors’ agreeing to it. If some of your creditors are onboard but others aren’t, that could make paying back what you owe trickier.
• Closing credit accounts. In most cases, you may be required to close one or more credit accounts to enroll in the DMP. This means you won’t be able to use those cards and you may be prohibited from applying for new credit.

A side effect of closing credit accounts while enrolled in a debt management plan is the potential credit score impact. A big part of your FICO credit score is based on your credit utilization, which is the percentage of your available credit you’re using. The lower this number is, the better.

When you close accounts included in a DMP while a balance is still owed, it can shrink your credit limit. As a result, your credit utilization ratio could shoot up, which may ding your credit score.

It’s also important to consider the commitment involved. Debt management plans only work when debtors are committed to seeing them through. But if they’re not addressing underlying problems with overspending or taking the plan seriously, it could end up being a failed effort.

Debt Management vs. Debt Consolidation vs. Debt Settlement

Debt management and debt consolidation are sometimes used interchangeably, but they aren’t the same thing. With debt management, you’re creating a plan to follow for repaying debt. Debt consolidation, on the other hand, involves combining multiple debts into one.

For example, you might take out a debt consolidation loan and use the proceeds to pay off all of your credit cards. You’d then make one payment to the debt consolidation loan going forward. A 0% APR balance transfer offer is another possibility for consolidating credit card debts.

Debt consolidation may or may not save you money on interest and fees. This depends largely on the terms of the debt consolidation loan or balance transfer offer you take advantage of. The timeline for repaying consolidated debts can vary, based on the length of the loan or how long a 0% APR balance transfer offer lasts.

Between the two, debt consolidation may offer more flexibility than a debt management plan. If you’re not necessarily struggling with debt, then you may consider consolidation options first before exploring a DMP.

Debt settlement allows you to settle debts for less than what’s owed. For example, if you owe $5,000 to a credit card, then your credit card issuer might agree to let you pay $3,500 and forgive the rest. This strategy assumes that you have cash on hand to pay the agreed-upon amount. It also assumes you’re late on bills and your credit score has suffered as a result.

Settling debts might be an option if you’re behind on debt payments and want to avoid filing for bankruptcy—though some experts recommend bankruptcy over debt settlement. It’s possible to negotiate a debt settlement with creditors directly or through a debt settlement company. Keep in mind that debt relief companies charge fees, typically a percentage of the amount of debt, for these services and it can take time to see results, which can mean further credit score damage.

If you feel debt settlement is your only option and you need help with the process, choose a reputable debt settlement company.

Who Is a Debt Management Program Good For?

Generally speaking, a debt management plan could be a good fit for someone who’s:

• Struggling to keep up with debt payments
• Wants to streamline monthly payments
• Would like to save on interest and fees
• Can afford the monthly payments required by a DMP

If you’re not sure whether a debt management program is the best option, talking to a certified credit counselor can help. Credit counselors can look at your income, budget, spending and debt to evaluate whether a DMP is a good fit. And, if it’s not, they can also help you decide whether you should consider another option, like debt consolidation or even bankruptcy.

It’s possible that you may not need any of those options. Instead, you may just need someone to help you tighten up your budget so you can find the extra money to make a dent in your debt. Again, that’s something a credit counselor can help with.

How to Choose a Debt Management Program

If you think debt management is the best way to tackle your financial situation, it’s important to compare companies carefully. While plenty of legitimate companies offer debt management services, the industry also has its fair share of scammers.

When researching debt management companies, check their credentials first. Look for a credit counselor certified by the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA).

Next, ask them for details about the services they provide and the fees they charge. Specifically, ask about:

• Which types of debt you can enroll in a DMP
• How long the plans last
• Interest rate reductions and fee waivers
• Estimated monthly payments
• Up-front and monthly fees

Also, be sure to understand what your responsibilities are once you enroll in the plan. For instance, it’s important to know when your payments are due and what can happen if you miss a payment or pay late. The more questions you ask beforehand, the fewer surprises there are likely to be once you’re formally enrolled in a debt management program.