If you’re one of the many Americans who are swamped with debt, don’t panic. It can sometimes feel like getting out of debt is impossible, but a strategy called debt management can provide a way out.
Whether you choose to enroll in a formal debt management plan with a licensed company or create your own strategy, debt management can help you get on top of your bills and avoid default or bankruptcy.
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What is debt management and how does it work?
Essentially, debt management means creating a plan to pay off your debts at a manageable rate.
It’s possible to do this on your own, but when people talk about debt management plans, they’re usually talking about formal programs offered by third-party companies.
How debt management plans work
Debt management plans (DMPs) are programs offered by credit counseling agencies, which are usually nonprofits. Once you enroll in a DMP, a credit counselor will work with you to create a payment schedule that you can stick to.
They’ll also usually negotiate with your creditors on your behalf to get you more favorable repayment terms (such as lower interest rates and lower monthly payments), which will make paying off your debts more feasible.
Instead of paying your creditors and debt collectors separately, you’ll make a single monthly payment to the credit counseling company. They’ll then distribute the money to your creditors. This will simplify your monthly payments and make it easier to stay on track.
Special characteristics of DMPs
There are a few things you should know about DMPs that set them apart from other forms of debt payment:
- Only unsecured debt is eligible: Debt management programs are specifically designed to help you cope with unsecured debt, such as unsecured loans, credit card bills, and medical bills. Secured loans (such as mortgages and auto loans) can’t be included in DMPs. 1
- Not all creditors will participate: Although many creditors will agree to the terms of a DMP if they think there’s a risk you won’t repay your debt otherwise, some may be unwilling to adjust their terms to make it easier for you to make payments.
- There’s no backing out once you’re enrolled: If you miss any payments, you could lose the benefits of a DMP. This is because creditors usually only agree to make concessions (such as lower interest rates) as long as you hold up your end of the deal.
- You may not be able to use your credit accounts: You may have to commit to closing your credit accounts and refraining from opening any new credit accounts until you’ve completed your DMP. 2 Make sure you have a pool of emergency funds so that you can stick to these terms.
Pros and cons of debt management plans
While a DMP may be a good option if you can’t afford your monthly bills, it’s worth considering all the pros and cons of debt management plans before you commit.
How to sign up for a debt management program
Signing up and completing a debt management plan involves several steps. Here’s the process you’ll go through when partaking in a DMP:
- Book a free consultation: Start by booking a 1-hour consultation with a reputable nonprofit credit counseling agency. A credit counselor will review your financial situation and give you advice on the best course of action.
- Sign up for a DMP: If your credit counselor recommends that you enroll in a DMP, then you can sign up for one. Before doing so, be sure to ask questions about what the program will cost, which debts you can include, and how long you’ll be enrolled.
- Pay your credit counselor: As mentioned, during your enrollment in a DMP, you’ll stop paying your creditors and instead send one payment to the credit counseling agency each month. They will then distribute your payments to your creditors.
If you’re on the fence about a DMP, don’t worry—there are really no downsides to at least booking the initial consultation. As mentioned, it’s free, and talking with a credit counselor won’t hurt your credit (or be recorded on your credit report at all, for that matter).
You don’t have to commit to anything you’re not sure about. Reputable counselors won’t pressure you to enroll in a plan until you’re sure it’s right for you.
Where to find the best debt management programs
It’s important to do your research before settling on a particular company. Make sure the DMP you choose is offered by a legitimate nonprofit credit counseling agency.
If you’re not sure where to start, visit the National Foundation of Credit Counselors or the Financial Counseling Association of America to find an accredited counselor in your area.
The best debt management companies don’t charge much for their services and have an excellent reputation for customer service. Make sure you know how much their DMP will cost before you sign up.
How to perform DIY debt management
Instead of signing up for a debt management program, you can also create your own plan for getting out of debt. This doesn’t come with the same advantages of a formal DMP—you won’t have anyone negotiating with your creditors, for instance—but it also won’t cost you any money, and you can do it on your own.
Here’s how to set up a DIY debt management plan in three steps:
1. Evaluate your finances
The first step to managing debt on your own is always to take a hard look at your financial situation to see where to focus your efforts.
Figure out how much you’re paying toward debts each month and how much you’re earning, and make sure you’re doing everything you can to limit how much that you’re using credit. If you’re juggling multiple debts, take note of which one is largest and which one has the highest interest rate.
2. Choose a debt payment strategy
There are several competing strategies for paying off debt. Choose one of the following:
- Snowball method: This is a popular approach to getting out of credit card debt. You start by paying off your smallest debts and slowly work your way up to larger debts. You’ll see progress early on as you reduce the number of accounts you’re managing, which is good for building confidence and keeping yourself motivated.
- Debt avalanche method: With this approach, you start by focusing on paying off your highest-interest debts and slowly work your way down to your lowest-interest debts. This method is more efficient than the snowball method because you’ll clear your debts sooner and pay less in interest overall.
The right method depends on your own mindset, so you’ll need to do some self-reflection to pick one. The avalanche method is more efficient—you’ll eventually clear your debts for less money—but it lacks the immediate gratification of the snowball method, so it’s harder to stick to.
Whichever strategy you choose for managing your debts, make sure you’ll have enough money left over at the end of the month to cover the cost of essentials, like rent and utilities.
3. Ask your creditors about hardship assistance programs
Contact your creditors and ask them if they offer hardship assistance programs (also known as “accommodations”). These programs may offer similar benefits to the ones you’d get from a DMP, such as lower monthly payments, a longer repayment term, or even fee waivers.
Creditors don’t usually publicize the existence of these programs (understandably, they don’t want to make it easy for people to pay less than they otherwise would have to), but if you ask them directly, they’ll volunteer the information.
Does debt management affect your credit?
Enrolling in a DMP doesn’t directly affect your credit score, but it can indirectly affect it in several ways. DMPs often have a negative impact in the short term and a positive effect in the long term.
Specifically, DMPs affect two key components involved in the calculation of your credit score:
Your payment history is the most significant factor affecting your credit score.
As long as you stick to the program, a DMP will have a positive impact on your payment history because it’ll guarantee that you pay your bills on time. This, in turn, will greatly benefit your credit score.
However, this is a long-term benefit—your credit won’t significantly improve after making just one or two on-time payments. You have to stick with the program to see your score go up.
Your credit utilization rate—the amount of your available credit that you’re using—is the second most important factor affecting your credit score.
Enrolling in a DMP may require you to close some or all of your credit card accounts. Closing a credit card account will hurt your credit because it’ll reduce the amount of available credit you have, i.e., it’ll raise your credit utilization rate. This will temporarily hurt your score.
Alternatives to debt management
If debt management isn’t right for you, then you have several other options for getting out of debt:
If you’ve got many high-interest debts (such as credit card debts) and you still have a relatively good credit score, then it may make sense to consolidate your debts using a debt consolidation loan or balance transfer credit card.
Much like a DMP, consolidating your debts will simplify your finances because you’ll only have one debt to manage. However, it does have a couple of drawbacks to consider.
For example, opening a new credit account (such as a loan or credit card) will cause a slight drop in your credit score, and you may need to pay balance transfer fees or added interest if you’re repaying your debt over a longer period.
If you have a secured loan (like an auto loan) that won’t fit into a debt management plan, then you could forfeit your collateral. This will get your creditor off your back and clear at least some of your debt to them.
Although any type of repossession will hurt your credit, voluntary repossession can save you stress from being hunted down by debt collectors and repo agents. It’ll also allow you to maintain some control over your financial situation.
If your debt is simply too big to pay off through debt management, you could try negotiating a debt settlement with your creditor or the debt collection agency that’s handling your debt. A debt settlement is an agreement to fully clear your debt in exchange for less money than you actually owe.
Beware that debt settlement comes with significant downsides. Settled debts still hurt your credit score (although not as much as unpaid ones) and not every company will agree to a debt settlement offer. Nevertheless, if you’re deliberating between debt management vs. debt settlement, you may be better off with a settlement if your debt is already in collections or your creditor won’t agree to a debt management plan or hardship assistance.
All you need to do is personalize a debt settlement letter template to fit your situation and send it to your creditor or debt collector.
If all other options are off the table and you feel like you have nowhere left to turn, then bankruptcy is always an option.
This is a last resort because of the heavy damage that bankruptcy does to your credit (and you should be aware that bankruptcies can stay on your credit report for 7–10 years). However, it will give you the chance to get a fresh start and begin rebuilding your credit without being overwhelmed by a mountain of debt.