8 Things You Need to Know About Debt Management Plans
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If you’re in debt and struggling to dig your way out, you’ve probably spent a lot of time trying to come up with a fix. Maybe you transferred your balance to a balance transfer card to score zero interest, and wound up racking up even more debt. Perhaps you’ve resorted to selling stuff to raise extra funds. Maybe you picked up a part-time job or extra hours at work to keep up with your monthly payments.
Whatever you’ve tried, it’s possible it’s just not enough. Enter debt management, which is an arrangement to consider if you need outside help to manage your bills.
What’s a debt management plan?
With a debt management plan, you work with a credit counseling agency who creates a realistic plan that can help you get out of debt. Typically, you deposit money each month with this agency, who in turn uses it to pay your unsecured debts on your behalf according to a payment schedule you agree upon.
When you get on a debt management plan, your creditors may also agree to waive certain fees or lower your interest rate. Obviously, these concessions could help you get out of debt even faster.
Still, there are details you should know and understand before you sign up for a debt management plan. These plans can be a lifesaver if you’re struggling, but they’re not for everyone. Here are some pros and cons you should be aware of. (See also: 5 Debt Management Questions You’re Too Embarrassed to Ask)
1. Debt management is not a loan
While debt consolidation requires you to take out a new loan to consolidate your existing debts, debt management doesn’t require a loan at all. “Debt management is a process for paying off debt through creditor concessions like interest rate reductions and late fee forgiveness,” says Mike Sullivan, Director of Education and a personal finance consultant with Take Charge America, a national nonprofit credit counseling and debt management agency.
You’re not taking out a new loan, but instead creating a long-term plan to pay off the loans you already have.
2. It can take up to five years to complete
Since debt management requires you to work with a credit counselor to create a realistic repayment plan, it can take a while to work your way through one of these plans. Sean Fox, co-president and CRO of Freedom Debt Relief, says debt management can take two to five years to complete, with the longer timelines typically reserved for those with the most debt.
That may seem like a long time, but remember that debt management intends to help you repay all the money you owe. If you owe a ton on credit cards and other loans, you can’t expect your problems go away overnight.
3. Debt management can save you money each month
You may be wondering how debt management can help you become debt-free when you’re barely keeping up with bills as it is. Fox says it’s important to remember that you’ll typically make just one monthly payment with a debt management plan, and that payment should be less than the total of all your debt payments now.
The lower payment is often the result of waived fees and negotiated interest rates, he says. Most of the time, your debt management plan will have you move excess funds resulting from lower monthly payments into a savings account.
4. It isn’t free
While debt management is a solution that works for many debt-saddled consumers, credit counseling agencies that offer these plans do charge for their services — even if they’re a nonprofit.
Fox says the monthly fees collected by enrolled consumers typically fall in the $10-$15 range. However, these fees are typically offset and more than made up for via savings gleaned from reduced interest rates.
5. Debt management should increase your credit score
One common alternative to debt management plans is something called debt settlement. With debt settlement, you work with a company (typically a for-profit) that offers to negotiate your debts down so you pay less than what you owe. One of the biggest downsides to debt settlement is the fact that debt settlement plans usually ask you to stop paying your bills, and that can cause your credit score to plummet.
“Debt settlement will always create a credit rating free fall,” says Sullivan.
With debt management, on the other hand, your credit score should actually increase as the process moves along. This is because, over time, your credit utilization will go down as you pay off debt. Not only that, but the on-time payments made by your credit counseling agency (as you make your own payments on time) will make a positive impact as well. Since your utilization is the second biggest determinant of your FICO score and your payment history is the biggest factor, debt management can help you raise your score by default.
6. Debt management is not for everyone
While debt management plans can be helpful for consumers who see them through, they aren’t the ideal option for everyone. Fox says that debt management is suited for people who are facing a less-severe financial hardship than a typical debt settlement customer. Generally speaking, this means consumers whose credit card debts are $7,500 or less, although there are plenty of exceptions.
For consumers with a lot more debt than this, you may need more than a reduced interest rate and debt management help to make any progress. Some may even want to consider bankruptcy.
7. You’ll learn new money management skills
Kyle Winkfield, managing partner of wealth management firm OWRS Firm, says that debt management plans can help you learn to use credit to your advantage.
Creating a management plan for how to effectively and efficiently pay off debt is “the best case scenario for leveraging debt in your favor, building credit, and instituting financial discipline,” he says. Once you’ve established a system and debt is being paid off, you also learn the valuable lesson that having less debt means having more money to save and invest. For that reason and others, “debt management is actually a great lifetime tool when properly structured and executed,” he says.
Ideally, you will take the lessons you’ve learned paying down debt in a debt management plan and use them to avoid debt in the future. (See also: 15 Tips From People Who Paid Off an Incredible Amount of Debt)
8. You can do it on your own
Finally, it’s important to note that many of the tasks debt management plans perform can be done by you. For example, you may be able to get your creditors to lower their interest rates and waive fees if you call and explain your situation. Whether you’re using a debt management plan or not, you could also sit down and take a look at your spending and create a budget that could allow you to spend less and throw more money toward your debts every month.
If you’re considering a DIY approach, Winkfield suggests starting with a comprehensive list of every creditor with updated balances and interest rates. You also need to know what your required monthly payments are. From there, you should track your monthly expenses to see if you have money available each month that can be redirected to eliminating debt.
Finally, you can create a debt repayment plan that will pay off all your bills over time. Many consumers like the debt snowball method where you focus on paying off your smallest debts first and make minimum payments on the rest, he says.
A debt management plan can do all of tasks with you, and may be the best option if you’re feeling overwhelmed and need help to start.