There are several ways to deal with overwhelming debt, and the right one for you depends on the severity of the problem and the resources you have. If you’re exploring debt management vs. debt settlement, you’re probably under some debt stress and looking for help. Here’s what you need to know.
What Is Debt Management?
Debt management, aka a debt management plan or DMP, is an arrangement in which you enroll unsecured debts into a plan and cover them with a single monthly payment. A credit counselor distributes this payment among your creditors. You’ll repay the full amount owed — debt forgiveness is not part of a DMP.
How Does Debt Management Work?
You access DMPs through debt management companies or credit counseling agencies. DMPs are designed to make your unsecured debt payments more affordable. “Of course, I’m asked all the time: ‘Why would my issuer agree to give me such a big break?’ The answer is simple. They don’t want you defaulting,” says Debt.com chairman Howard Dvorkin. “Then again, they don’t want you taking advantage of them. So, they work with nonprofit credit counseling agencies they trust.”
Debt management programs may include financial education and budgeting advice. After consulting with your credit counselor, you’ll enroll your debts into the plan. Note that debt management plans can only be used for unsecured debt like credit card balances, personal loans and medical debt.
Your counselor will work with you and your creditors to come up with a repayment schedule. Creditors may be willing to reduce your interest rate, lower your payment and/or waive certain fees.
Every month, you’ll make a payment, which includes a program fee. Your counselor distributes this payment among your unsecured creditors. Good credit is not required to qualify for a DMP, but you need enough steady income to afford the monthly payment and clear your debt in five years or less.
[SEE: Best Debt Settlement Companies]
Debt Management Pros and Cons
Debt management programs can be effective for getting out of debt, but they’re not a free lunch.
Pros
— Reduced interest rates and payments can make your debt more affordable. Nonprofit credit counseling agency Money Management International says its clients save an average of $32,000 on its plan. Cambridge Credit Counseling says, for those enrolled in a DMP, the interest rate for common creditors was reduced by more than half, from from 21.8% to 10.6%.
— Consolidating several loans into one payment simplifies your bills and helps you avoid paying late.
— The fact that you’re in a DMP may be noted on your credit report but doesn’t directly impact your credit score.
— Making payments on time builds good credit history, and paying down balances lowers credit utilization. This can raise your score.
Cons
— “If there’s a downside to a debt management program, it’s that Americans can be impatient — and a DMP can take 36 to 60 months to pay off your debt,” Dvorkin says.
— You’ll probably have to close credit cards enrolled in a DMP, and you’ll also be prohibited from opening new accounts. Both of these things will cut your access to credit and can lower your credit score.
— You have to pay off the entire balance. If your income isn’t stable or sufficient, you won’t qualify for a DMP or you won’t be able to complete it. Cambridge Credit Counseling’s data indicates that about half of its clients successfully completed its program.
[Read: Best Debt Consolidation Loans.]
What Is Debt Settlement?
Debt settlement is an arrangement you make with your unsecured creditors in which they accept less than you owe and forgive the rest. This partial repayment is usually a lump sum but can also be a series of payments. DIY debt settlement is possible, or you can hire a service.
How Does Debt Settlement Work?
Why would a creditor accept less than you owe? It won’t — unless it has reason to believe that the full amount might be uncollectable or too difficult or expensive to pursue. Here are the elements of a typical settlement:
— The account is months past due and either charged off or about to be.
— The debtor has a financial hardship.
— The debtor is able to offer a lump sum or, less commonly, a series of payments to settle the account.
Typically, you must come up with money to offer your creditors before you or someone working on your behalf can approach them with an offer. Most people stop paying their accounts. This allows them to demonstrate that they can’t afford the debt while saving money for a settlement offer.
“Clients are not required to stop making payments to enroll in a debt settlement program,” says Jason Pack, chief revenue officer at Freedom Debt Relief. “However, successful negotiations typically depend on the debt being delinquent.”
Debt settlement only works with unsecured debt. A secured creditor would simply repossess your collateral if you don’t pay up.
Debt Settlement Pros and Cons
Debt settlement can get you out of debt for less, but it can be a risky strategy, and there may be unexpected costs.
Pros
— The monthly debt settlement plan payment is more affordable than mandatory payments to your creditors.
— You may clear your debts sooner and for less money.
— You don’t need to be able to afford your debt payments. In fact, you have a better chance of settling if you’re experiencing financial hardship.
Cons
— Your creditors will probably keep contacting you and may even take you to court.
— Missing payments and settling can cause major credit score damage — drops exceeding 100 points are not unusual.
— Forgiven amounts may be taxable unless you’re insolvent.
— Professional debt settlement fees can be high, depending on where you live — 25% of the amount enrolled is typical.
[Read: Secured vs. Unsecured Debt.]
DMP vs. Debt Settlement: How to Choose
The debt management plan vs. debt settlement decision is actually pretty simple. Debt management is geared to those who can afford to repay their debts in full if their payments are restructured. It’s a less drastic solution that provides some breathing room with little or no credit score damage. If you can afford a DMP, it’s probably the right solution.
Debt settlement may be appropriate if you can’t afford a payment that would clear your debts within five years or don’t qualify for a debt management plan. It can be helpful if you have a verifiable financial hardship like a job loss or illness.
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Debt Settlement vs. Debt Management: What’s Better? originally appeared on usnews.com
