Wondering what is Debt Management? We got you!
From Student loans to overwhelming credit card loans, paying off debt can be an enormous struggle for many people.
Debt management can help you get yourself out of your debt sooner than you thought and rebuild your credit.
However, before you commit, you must understand how debt management works.
In this guide, we’ll be talking about everything you need to know about debt management and how it can affect your finances.
- A DMP plan can help you in avoiding bankruptcy.
- DMP’s are meant for priority debts like credit card debt and does not cover student loans, medical bills, mortgages, or car loans.
- You can either hire a credit counseling agency or choose the DIY approach to create a debt management plan.
- DMP can help you in paying your debts faster with a lower interest rate.
What Is Debt Management Plan?
A debt management plan is an informal agreement between you and your creditors to pay back your non-priority debts by one single monthly payment, which will be divided between your creditors1.
A debt management plan is a great way to avoid bankruptcy and decrease your existing debt and move forward to eliminate it without inflicting severe damage to credit scores.
Debt management plans typically cover priority debts like credit card debts and won’t help with other forms of debt such as student loans, medical bills, mortgages, or car loans. 2
How Does Debt Management Works?
You can either do it yourself or hire a credit counseling agency to help you create debt management to pay unsecured debt through financial planning and budgeting.
1. DIY Debt Management
In a DIY plan, you will create a plan that fits your financial situation and specific budget to pay off your debts while maintaining your financial stability.
The Debt Avalanche or Debt Snowball method is the best DIY version of debt management.
2. Debt Management through Credit Counselor
If you opt to do debt management through credit counseling, you’ll have to contact a credit counselor in your area who will review your financial situation and the debts you owe, and help you create a plan to repay your debt.
Once you agree with the plan, the counselor will contact your lenders to negotiate the terms, such as lowering your interest rates or monthly payments, waiving fees, or reducing the amount you owe.
Once your credit card issuers agree to the plan, you’ll make a single payment to the credit counseling agency, which will then distribute the money to all your creditors.
3. Debt Relief Company
You can also choose to hire a debt relief company. These companies negotiate with your lenders to reduce your debt.
If you sign up, you will start making payments to the debt relief company held in a separate account and will be asked to stop making payments to your creditors.
Once your agency convinces your creditor to a settlement, the amount you were accumulating in a separate account will be used to pay your creditors.
Also, you will have to pay a small percentage to the debt relief company as their fees. 3
Should You Choose Debt Management?
A debt management plan is a powerful tool for regaining control of your finances. Following are the circumstances under which you should choose debt management:
- You have heavy credit card debt.
- You have a poor credit score to qualify for a personal loan or a balance transfer credit card.
- You have debt that you can’t pay from your funds or debt consolidation
- You need an effective plan to avoid more debt from adding to your account.
Pros & Cons Of Debt management
Here are some pros and cons that you should consider before taking a leap:
- The primary benefits of the Debt management plan are the faster payoff time and lower interest rate.
- You only need to make one monthly payment to your credit counseling agency, typically much less than what you pay on your combined debts.
- DMP will stop any ongoing collection attempts from the collection agencies, such as phone calls and letters.
- Have little or no impact on your credit scores than debt settlement or bankruptcy.
- A debt management plan generally won’t cover secured debts and a few unsecured loans such as student or car loans.
- You’ll be required to stop using any credit cards, not a part of the debt management plan to diminish your access to the credit.
- You’ll be charged an initial fee and then a monthly fee to participate in the Debt management plan. 4
Effect of Debt Management on Your Credit Score
Debt management can be useful in helping you get out of debt, but it also has negative consequences on your credit score:
If you choose a method of debt management that requires you to withhold funds and stop making payments to your creditors, then that will lower your credit score.
You have to bear a hard inquiry sometime during the debt management plan.
Especially when you try to get a lower interest rate, a hard inquiry will damage your credit score for a year and will remain on your credit report for two years.
However, if you do get a lower interest rate, then you will be able to make monthly payments with ease, and this will set back your credit score right back on track.
Credit utilization ratio
Credit utilization accounts for 30% of your credit score, and it tells how much debt you can carry when compared to your credit. The ideal credit utilization should be between 10-30. 5
Alternatives of Debt Management
If you think debt management is not for you, then here are some of its alternatives that you can consider:
By taking a personal loan, you can pay back your high-interest credit card loan.
This will not bring you out of debt instantly, but it will help you save money that you are paying towards a high interest rate. However, the personal loan interest rate can is ideally between 5-35%.
So this option will be fruitful for you only if you have a credit score of more than 600. That way, you will qualify for a low-interest rate, and taking a personal loan will then make sense.
In this, you transfer all your credit card debt to a new card with a zero balance APR offer. This will allow you to save at a high-interest rate.
However, there are two things to be kept in mind with this method.
First is that you may have to pay a balance transfer fee, and the second is that you will not pay interest charges only as long as the promotional period lasts.
Debt settlement is nothing but making your creditors agree to accept a lower amount rather than the original amount you owe.
There are two ways to approach this. You can either hire a credit counseling agency (explained above), or you can do the DIY method.
In a DIY debt settlement method, you basically do the negotiation yourself.
This might be a better choice for you if you have a good credit history or positive past records in the eyes of the creditor. 6
In this guide on what debt management is, we broke down what the term means, what are its advantages and disadvantages, how it affects your credit, what its alternatives are, etc. We hope this guide was useful to you.
Can I take more credit cards while on a DMP?
DMP might allow you to have one credit card to use in emergencies. You cannot use your existing credit cards during a debt management plan.
How long does a debt management plan lasts?
Debt management plan idelaly lasts for 2-5 years.
Amit Gupta is the founder of National Planning Cycles, a company that helps startups, individuals, and small businesses with their financial planning. He has a vast amount of experience in the finance sector, having managed Google Play accounts for some of the world’s most successful unicorns. Amit is an expert in his field, and he uses his knowledge to help others achieve their individual goals.
The National Planning Cycles is committed to producing high-quality content that follows industry standards. We do this by using primary sources, such as white papers and government data alongside original reporting from reputable publishers that were appropriate for the accuracy of information while still being unbiased. We have an editorial policy that includes verifiable facts with due credit given where applicable.