If you’re struggling with too much credit card debt, or you’ve lost control of your loan repayments, knowing that the bills are stacking up while your credit score takes a dive can feel dismaying. Fortunately, there are debt relief services that can help you financially recover. However, it’s important to pick the right service for your situation.
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Debt management vs. debt settlement: which is better?
When you enroll in a debt management plan (DMP), a nonprofit credit counseling agency works with your lender to set up a more manageable repayment plan. You still have to repay your debt in full, but you may be able to do so with smaller monthly payments over a longer period, and your lender might be willing to give you more favorable terms (such as a lower interest rate) as long as you stick to the DMP.
By contrast, with debt settlement, you negotiate with your lender to pay off your debt for less than you owe. You’ll usually begin this negotiation after a long period of nonpayment, during which your debt will become seriously delinquent. During this period, you’ll probably rack up late fees and damage your credit score.
How to choose between debt management and debt settlement
In general, if your income is sufficient to pay off your debts and you just need a little extra help, you should choose debt management.
Debt settlement is much riskier and more harmful to your credit than debt management. It’s a viable option if paying off your debts in full just isn’t a realistic option, but it’s best if you treat it as a last resort.
To decide which is right for you, it’s necessary to fully understand how debt management and debt settlement work. In the following sections, we’ll break them down in more detail.
What is debt management and when should you choose it?
Non-profit credit counseling agencies offer debt management plans as a way to make your debts more manageable.
When you enroll in a DMP, your counselor can negotiate with your lenders on your behalf to get you the following benefits:
- A longer repayment schedule (which means lower monthly payments)
- Lower interest rates
- Fee waivers (e.g., enabling you to avoid paying late fees you’ve already incurred)
They also provide financial coaching to help you make a realistic budget and improve your credit score.
Why choose debt management?
There are many reasons you should consider enrolling in a debt management plan:
- You’ll have lower monthly payments: If your credit counselor convinces your lender to lower your interest rate or waive your fees, you’ll pay a lot less each month.
- You’ll only make one monthly payment: When you’re enrolled in a debt management plan, you only have to make one monthly payment (to your credit counselor). They’ll act as a go-between and distribute the money to your creditors. This makes it easier to keep on top of your bills.
- It’s easier on your credit score: A debt management plan won’t hurt your credit score as much as debt settlement or bankruptcy. You might see an initial drop in your credit score if your counselor closes any of your accounts, but as long as you stick to the plan and pay your bills on time, your credit score might actually increase in the long term.
If you’re on the fence, you can always book an initial consultation with a credit counselor to discuss whether this option is right for you. Your first consultation will probably be free (if it’s not, just look for another credit counseling agency), and credit counseling can’t hurt your credit, so there are no real downsides to at least talking it over.
What is debt settlement and when should you choose it?
Debt settlement is an agreement between you and your creditor in which your creditor agrees to clear your debt for less than the amount you actually owe. You can negotiate a debt settlement yourself or hire a debt settlement company. However, debt settlement companies usually charge a fee, which often reaches or exceeds 20%–25% of the settled debt. 1
Unless you already have enough savings to offer a settlement, the process generally takes three years or more. 2
Why choose debt settlement?
There are a few reasons why you might consider settling your debt:
- You need to pay less than you owe: The main draw of debt settlement is the fact that you won’t need to pay all your debts. According to research by the American Fair Credit Council, borrowers usually settle for less than half of the total amount owed. 3
- You already have poor credit: If you already have a bad credit score, you won’t need to worry as much about how settling a debt will affect your credit score. Both the settlement itself and the delinquencies you’ll incur while saving up for a settlement offer won’t be as impactful as they’d be if you had good credit. 4
- It can help you avoid bankruptcy: Bankruptcy is generally the most damaging kind of mark that can appear on your credit report, so it’s best to avoid it if at all possible. 4
How much (or how little) debt collectors agree to settle for depends on the size and age of your debt. Many debts that have been charged off are sold to collection agencies for only a fraction of their original value, which means that debt collectors have an incentive to sometimes accept settlement offers. 2 If they didn’t buy your debt for its full value, they can still turn a profit if you’re able to offer a partial payment.
This is especially true for older debts. An analysis conducted by the FTC in 2013 revealed that debt buyers paid an average of 7.9 cents on the dollar for debts that were less than 3 years old, whereas they paid an average of 2.2 cents on the dollar for debts that were 6 to 15 years old. 5
What type of loans can you manage or settle?
Debt management plans and debt settlement both work for unsecured debt, such as unsecured loans (like personal loans) or credit cards. These types of debt don’t require you to put up collateral (like a car or house) that your lender can seize if you default on your payments. This makes it easier to fall into debt that you can’t pay off.
Many debt management plans are specifically designed to help you get out of credit card debt, whereas debt settlement is more widely applicable. With that said, there are some situations where debt settlement simply won’t be an option. According to a recent survey by the Consumer Financial Protection Bureau (CFPB), many credit card companies have a policy of agreeing to new repayment plans for borrowers in debt management plans but refuse all debt settlement offers. 6
How to find credible debt management and debt settlement services
It’s particularly important to find credible debt relief companies if you’re having credit problems because scammers are more likely to target you. 7
Take the following steps to ensure you’re seeking help from the right people:
- Look for accredited companies: If the National Foundation for Credit Counseling has accredited the debt management agency you’re considering, they’ve been rigorously vetted by a third-party organization, so they’re probably credible. You can also visit the Better Business Bureau’s website to look for legitimate debt settlement companies.
- Contact your state attorney general: You can check if there are any official complaints against the company you’re thinking of hiring by contacting your state Attorney General’s office.
- Check whether the agency charges reasonable fees: Try to get quotes from several different companies to get a general idea of how much debt management or debt settlement is going to cost you. If a company is charging unusually high fees, they may be trying to scam you.
If you’re struggling to pay your bills, don’t rush your decision. It’s better to take your time and do your research before you pick a debt management or debt settlement company. Beyond these options, there are other ways to handle collectors when you can’t easily pay off your debts.