What Is a Debt Management Plan? How Can It Help?
A debt management plan is a way to pay off high-interest unsecured debt – mostly credit cards – without having to take out a bank loan.
Debt management plans reduce the interest rate on credit cards to around 8% and make monthly payments affordable, so consumers can pay off debt in 3-5 years.
The plans are offered by nonprofit credit counseling agencies, who do a detailed analysis of your income and expenses to create a household budget that includes a fixed monthly payment tailored to what you can afford. The plan is presented to credit card companies, who must approve the plan.
Those who enroll make monthly deposits with a credit counseling organization, which uses that money to pay the debts according to a predetermined payment schedule developed by the counselor and your creditors. Your monthly payment is tailored to what you can afford.
Once approved, a debt management plan simplifies the payment process for consumers who use 3-4 credit cards with 3-4 deadlines and 3-4 minimum payments to remember each month.
One payment to one source, once a month – and no loan! – is how a debt management plan makes managing your money easier.
Debt Management Plan Pros and Cons
Everyone’s financial situation is different, so a debt management plan will work with differing levels of effectiveness for different people. A DMP has both advantages and disadvantages, and it’s important to be aware of all the factors before signing on to one.
So, where to start? Recognizing the type of debt you’re carrying is step No. 1. For example, if your mortgage and/or auto loan are what’s dragging your finances down, a DMP won’t help, as those debts are secured by your house and your car. Debt management plans address unsecured debt – debt without collateral -- such as credit card balances and personal loans.
A DMP can help with that kind of debt, but the help comes with some conditions that might not work for you. Here are debt management plan pros and cons.
Pros of a Debt Management Plan
- Offers credit card consolidation without a loan, meaning you don’t need to take on more debt to pay off your existing debt.
- It will help you stay more organized and punctual with your bills and payments.
- It creates a realistic monthly budget with a financial goal that can get you out of debt within 3 to 5 years.
- Making regular and timely payments can improve your credit report and credit score over time.
- If you’ve been delinquent about paying bills, a DMP can bring your credit accounts to current status, called “re-aging.” That, too, can help your credit score, though your credit report likely will still contain the information about past late payments and delinquencies.
- It will save you from late fees that make matters worse for your finances.
- Creditors or debt collectors will stop calling.
- You’ll be given advice about your finances from a professional
Cons of a Debt Management Plan
- You’ll be required to close your credit card accounts to avoid taking on even more debt.
- You won’t be allowed access to new lines of credit such as an auto loan or a loan to remodel your home.
- You must commit to making the single monthly payment consistently.
- Some of your creditors may not approve the plan, meaning you’ll be obligated to pay them separately from the monthly DMP payment.
- The credit counseling agency might charge a small enrollment fee and/or monthly maintenance fee, though some of those can be waived.
If you have a steady income that you can use to pay off your unsecured debt at a lower interest rate than you’re currently paying, and if you can survive without needing new lines of credit over the length of the plan, then a debt management plan might work for you.
Do Debt Management Plans Affect Credit?
Your payment history accounts for 35% of your FICO credit score. Assuming you make your monthly DMP payments to the credit counseling agency consistently and on time, your credit score will improve over the term of the program because the DMP is making consistent and on-time payments to your creditors for you.
If you’ve been delinquent, the DMP establishes a regularity to when and how much you are paying back your creditors, and the credit agencies will take notice of that positive direction in your payment history.
Another 30% of your FICO score is determined by the amount of your total debt. Less debt, better score. The fact that the DMP will get you out of debt in three to five years eventually will have a positive effect on your credit. When you successfully emerge from the DMP free of your unsecured debt, your credit score can go up by 100 points or more.
There can be a couple of catches, though. If lenders look at your full credit report while you are in a DMP, they will see that you are repaying the debt at a reduced interest rate and it may affect their final decision on whether to grant you a loan.
Plus, one of the conditions of a DMP is the requirement that you close all of your credit card accounts to keep you from running up new debt, and that in turn will lower your credit limit. But one of the other big factors in your FICO credit score is your credit utilization ratio, which means the percentage of your available credit you use. Your credit score is happier when that percentage is low.
The more credit cards you have, the more available credit you have. That makes it easier to keep your credit utilization ratio down. But if your credit limit suddenly plummets when you close those accounts, there’s a good chance you’ll use a higher percentage of what’s available to you. If you go much over a 30% credit utilization ratio, your credit score could take a hit.
The good news is that the credit utilization effect on your credit score should be temporary. After the first eight or 10 months of consistent monthly DPM payments to decrease the amount of debt you owe, the credit utilization percentage will fall and your credit score will see a bump up.
One of the pluses to a debt management plan in terms of the effect on your credit is that you will pay off the total amount of what you owe your creditors. A debt settlement option, on the other hand, involves a company negotiating lower payments for you that don’t cover the full balance you owe.
You might save some money with a debt settlement, but the fact that you didn’t meet your entire obligation will negatively affect your credit score.
Considering a Debt Management Plan
The statistics show that a DMP isn’t a sure thing for everybody. Pre-pandemic, credit counseling agencies nationally were recommending DMPs to about half of the people who came to them for help with their debt, but that number has dropped during the pandemic. According to the National Foundation for Credit Counseling (NFCC), just over 30% of financial counseling sessions conducted by its member agencies involved a recommendation to enroll in a DMP as of the fourth quarter 2021.
Too, the percentage of people who enroll and then complete the 3 to 5 years of a debt management plan ranges from 55% to 70%, depending on the interest rate being charged on the debt during the course of the program The lower the interest rate, the higher the completion rate for DMPs.
Most people who drop out of a debt management plan do it either because they encounter more unexpected financial problems after the program has started, or because they find the monthly budgeting restrictions too burdensome.
That’s why it’s important to choose a credit counseling organization that will advise you wisely about the process before you sign up for a debt management plan. Many of these organizations are nonprofit and most offer counseling sessions free of charge.
The Federal Trade Commission (FTC) recommends finding a reputable credit counseling organization that uses certified counselors trained in consumer credit and debt management. They can help manage debt as well as develop a practical budget.
It’s also vital to check with the local consumer protection agency, the Better Business Bureau and your state’s Attorney General’s office to ensure there haven’t been any consumer complaints and the organization is licensed.
Beware of hidden fees, scams and fraudulent organizations. Look up a company’s record with the Better Business Bureau to check its track record. Once you find a credit counselor with whom you’re comfortable, he or she will review your finances and help you create a budget, as well as help you decide whether a debt management plan is right for you.
Some points to remember when enrolling in a DMP:
- It can take 36 to 60 months to repay debts using a DMP.
- The organization may restrict you from using or applying for additional credit while enrolled in the plan.
- If DMP payments are late, you may lose progress on decreasing the debt and lowered interest rate or fees.
- You may qualify for lower interest rates on your debt and a lower monthly payment.
If you have a steady income that will allow you to make the monthly payments, and if your unsecured debts (especially your credit card debts) are between 15% and 39% of your annual income, a nonprofit debt management plan might be the best solution for you. Of course, there are other factors besides that ratio of unsecured debt to annual income that weigh into a decision about a DMP.
Signing up for a Debt Management Plan
If you decide a debt management plan is right for you, your credit counselor can help you enroll. He or she will work with your creditors to negotiate interest rates and to come up with a payment schedule, which you will review and approve before beginning the plan.
Once it is determined how much money is left after basic living costs such as rent, mortgage, utility bills, secured loans and living expenses are paid, the remaining amount can be divided among creditors.
Then, you’ll make a deposit monthly to your credit counseling organization. In turn, the organization will distribute the money to your creditors according to the agreed-upon payment schedule.
Participating in a debt management plan will cost you very little. After counseling sessions, you should only pay a small one-time set-up fee and a small monthly maintenance fee. Avoid any credit counseling organization that requires an application fee, membership fee, upfront fee or per-creditor fee.
After you enroll in a plan, follow these guidelines to help ensure that the program is working for you:
- Make note of which of your debts and bills will be paid via the DMP and which ones you still must pay on your own each month.
- Pay the counseling agency on time each month.
- Review your monthly statements to ensure that the counseling agency is paying your bills on time and according to plan.
- Remember that a debt management plan typically takes care of only unsecured debts.
Step-by-Step Process for Debt Management
If you are interested in participating, it is best to go online to research the best debt management companies and find one you are comfortable using.
There are nonprofit and for-profit companies that offer DMPs. The nonprofits are considered more reliable because their credit counselors are trained and certified by the very respected National Foundation for Credit Counseling.
Before calling a company, make a list of your monthly income and expenses. Be as accurate as possible, using recent pay stubs and bank statements, along with a list all bills paid and unpaid. Have all that information available when you call the company.
Here is step-by-step description of what to expect from a good debt management company:
- Be prepared for an interview that will touch on all areas of your income and expenses, including rent, utilities, credit card bills, medical bills, and any other financial obligations.
- During the session, the counselor will pull your credit report and verify information with you. This is a “soft pull” which means there will be no effect on your credit score.
- The counselor should make suggestions on areas where you could decrease spending and increase income as well as offer free education material for use down the line.
- The counselor will evaluate your position and if your cash flow situation is still a negative, the counselor could offer a debt management program as a solution.
- If you agree to enroll in the program, the counselor works up a budget proposal and sends it to your creditors for them to approve or make a counter proposal.
- You and the creditor have to agree on the final terms that include monthly payment, fees involved and how long the payment schedule will run before the debt is eliminated.
- In most cases, when both sides agree to the terms the counselor will ask for your bank account information so that monthly payments come automatically from your account. The payment goes to the credit counseling agency, which then disburses money to the creditors under the agreed upon terms.
- The agreement is sent you via email or regular mail. Once it is signed and returned (typically one day for email, 3-5 business days for regular mail), the program begins.
- You will receive monthly statements from both the creditor and the credit counseling agency. Compare the two statements to be sure payments are credited properly.
- If one debt is paid off before the others, your monthly payment remains the same. Any extra funds are split among the remaining creditors to pay off those debts faster.
If you have any questions about the terms or conditions, call the credit counseling agency in charge of the agreement. They are your liaison with creditors and can smooth out any issues you have.
If you suddenly run into an unexpected amount of money, you can pay off your balance early with no penalty.
Things You Should Know About Debt Management Programs
A debt management program is one way to dig your way out of debt troubles, but there are some things that should be considered before enrolling.
- DMPs are 3-to-5-year programs. That requires a lot of discipline and commitment. If you drop out of the program for any reason, you lose all the concessions creditors made for you on interest rate reduction and elimination of penalties for late fees, etc.
- You will be asked to close all credit card accounts while in the program, although some agencies may allow one card for emergency use. This can be a difficult hurdle for people.
- Be sure to call your creditors and verify that they have accepted the terms of the debt payment plan proposed to you by a credit counseling agency.
- There are other debt-relief options available, including doing everything in a DMP by yourself. You could also look at a debt consolidation loan; a debt settlement program and, if your circumstances are truly dire, even bankruptcy as possible solutions.
Responsibilities in a Typical Debt Management Program
A successful debt management program involves serious discussions among consumers, nonprofit credit counseling agencies and creditors to construct a plan that eliminates all debts and steers the consumer toward responsible use of credit.
Each party has a role to play in building a foundation for success.
The consumer’s role includes:
- Be honest and accurate when providing information about income and expenses.
- Be disciplined about making full payments, on time, every month.
- Track your progress through statements every month.
- Avoid new credit. There could be severe penalties for trying to open new lines of credit.
- Take advantage of free educational information provided to help in managing debt.
The credit counseling agency’s role includes:
- Thoroughly review the consumer’s financial situation and suggest possible solutions to eliminate debt.
- Offer educational tools that help consumers understand the root causes of their debt; why it’s important to budget properly; and how to avoid debt in the future.
- Work with creditors to reduce interest payments and waive or reduce penalty fees.
- Serve as the liaison between consumer and creditor to arrive at an affordable and acceptable monthly repayment schedule.
- Provide monthly status reports on the amount paid to each creditor, and the remaining balance.
- Be available to answer questions while the repayment process is taking place, and follow up with the consumer when the program is completed to update the available educational tools.
The creditor’s role includes:
- Be open to designing a repayment schedule with which both sides can live.
- Be prudent, but fair about making concessions on interest rates and penalty fees.
- Keep accurate records of payments and provide the consumer with monthly status reports.
- When the debt is fully repaid, send a status update to the national credit reporting agencies.
If the three parties work together responsibly, the program should eliminate all debts within 3-to-5 years.
Avoiding DMP Pitfalls
It’s important to investigate the debt management company prior to agreeing to terms or signing any paperwork. Search for one that is accredited.
Don’t be tempted by “credit repair” companies that promise to fix credit histories for a fee. All consumers have the right to have inaccurate information removed from a credit report without the need for an outside organization.
Most importantly, when you determine which debt management plan is most efficient, find out what services the business provides and all costs. Never rely on verbal promises. Get everything in writing, and read the contracts carefully.
Debt Management Plan FAQs
Most debt management companies require you to close credit card accounts since those are usually the cause of debt. Some companies will allow you to retain one credit card for emergency, travel or business use. The good news is that credit card companies are eager to renew a relationship with you when you complete the program.
No. All eligible unsecured debt must be accounted for in a debt management plan, even those bills that you typically have no problem making payments on. The credit counseling agency in charge of your debt payment plan will want a full accounting of income and expenses in order to arrive at an accurate amount available to make the monthly DMP payments so be prepared to include all eligible debts.
Consumers can sign up online, but most go through a phone interview with a credit counselor to determine if their situation qualifies for a DMP. The phone interviews range from 20-60 minutes, depending on which debt management company you’re working with.
Creditors usually make concessions on the interest rate in debt management plans – often dropping them from as high as 30% to somewhere close to 9% -- but it is rare for them to waive all interest charges. Interest rates are variable and the credit counseling agency will work to get you the best rates possible.
Both are possible solutions to problems with debt. A debt management program is not a loan. It consolidates unsecured debts and tries to lower monthly payments through reductions on interest rates and penalty fees. A debt consolidation loan is actually a loan, with interest charges and monthly payments due. With a debt consolidation loan, you would have to qualify to borrow the amount needed to pay off your debt. The interest rate is normally fixed and, depending on your credit score and history, may need to be secured with collateral like a home or car. Debt consolidation loans usually run 3-5 years.
The best debt management companies typically are nonprofit credit counseling agencies, who normally charge somewhere between $25 and $55 per month. There also is a set-up fee that varies by state, but the industry average is around $75.
Unsecured debt such as credit cards and medical bills are, by far, the most common debts associated with debt management programs. Utilities, rent and cell phone services are other types of unsecured debt that could be part of a DMP. Some installment contracts, such as country club or gym memberships also could be eligible. There is no hard-and-fast rule for how far in debt you must be to get in a program, but most creditors and legitimate credit counseling agencies say your financial situation needs to be severe. In other words, you must owe more money than your income and savings can reasonably handle. Secured debts, such as a mortgage or auto loan, are not eligible for the program.
Most reputable debt management companies offer 3-to-5 year programs to eliminate all debt. If the consumer comes into a windfall of cash, there is no penalty for paying off debt early.
The goal is to lower the interest rates you pay on all debt eligible for the program. Some debt – mortgages, auto loans – is not eligible so the interest rates there will not be affected.
The convenient answer is: When your debt is so small that you can handle it yourself by doing a better job of budgeting; or when your debt is so large that there isn’t enough income to pay for basic living needs AND make a payment toward your debt. The truth is that everyone’s circumstances are so different that an interview with a credit counselor is the only way to know whether you qualify for a DMP.
A DMP is an attempt to consolidate debts into one payment by reducing interest rates and reducing fees. Bankruptcy is a legal declaration that you can’t repay debts, even after all assets are liquidated. Filing for bankruptcy remains on your credit report for 10 years and can cause your credit score to drop by as much as 200 points.
Although most unsecured debts are included, not all unsecured debts qualify for inclusion in a debt payment plan. For example, most agencies allow one credit account to remain open for emergency or business use.
Online research is the easiest place to find companies that do DMPs. It is suggested that you look for National Foundation for Credit Counseling (NFCC) approved non-profit agency. Credit counselors at NFCC approved agencies must be trained, certified and adhere to strict quality standards in developing debt payment plans.
The top benefit is that you are on a plan that should eliminate debts in 3-to-5 years and you will stop receiving harassing calls from debt collection agencies. Convenience is another plus. You make only one payment a month for your debt payment plan as opposed to numerous payments with numerous deadlines. You receive free educational material that should help you better understand how to manage debt. Finally, you can always call a credit counselor and receive free advice should your situation change.
No, creditors should stop calling you as soon as you start a debt payment plan and yes, they also will continue to send statements, which is important. Statements from the creditors should be matched up against statements from the credit counseling agency to make certain all payments are being applied correctly.
Reputable debt management companies will keep your information confidential, but be sure to review your organization’s privacy policies. If you find that they do share your information with anyone, there should be a place to opt out.
The credit counseling agency will inform all creditors of your intention to enroll and ask each one for concessions on interest rates charged and penalties applied to your account.
The credit counselor should be able to advise you during the counseling session whether a creditor will participate. If, for any reason, the creditor chooses not to participate, the original terms of the debt remain intact.
If circumstances change while you’re in a DMP and you can no longer make agreed upon payments, contact the agency and they should work with you to adjust payments accordingly.
Contact your bank and stop payments to the agency servicing your debt management program as soon as you become aware the agency has shut down. You should immediately contact the creditors involved and ask if you could continue paying them directly or would they work out another payment plan. Also, ask for a credit report and verify that previous payments you made to the DMP agency were sent to your creditors. If payments were missed, there could be some negative consequences to your credit score. Finally, you could contact a nonprofit credit counseling agency and ask them to intervene on your behalf with your creditors.
If you find you have a healthier cashflow than your debt management plan budgeted for you, you can increase the amount of your monthly DMP payment either on a one-time basis or over a number of months. It’s never a bad idea to speed up the pace of your debt repayment when you can afford it. You should always let the credit counseling agency know in advance when you intend to submit more than the minimum payment.
You might still receive them early in the debt management plan. It could take up to three consecutive on-time payments through the DMP before the program will stop collection calls completely.
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