Weigh the advantages and disadvantages of debt management plans so you can decide if it’s the right debt solution for you.
A debt management plan is an assisted form of debt consolidation. It’s a voluntary debt repayment plan that you set up through a nonprofit consumer credit counseling agency. It has its advantages and disadvantages, so it’s important to make sure this is the right solution for your needs.
Debt management pros
#1: You can use this solution even with bad credit
Credit score is not a factor to qualify for a debt management program. That means you can have rock-bottom bad credit and still use this solution. That’s a huge advantage over other do-it-yourself debt consolidation solutions, which require good to excellent credit to use them effectively. This is effectively the only way to consolidate debt into a single monthly payment for people with bad credit scores.
#2: It offers one low monthly payment to cover all your bills
Consolidation simplifies bill pay because it rolls all your credit card debts into a single monthly payment. That payment is typically lower than what you paid on all your bills individually. In the case of a debt management plan, a DMP usually reduces your total monthly payments by up to 30-50 percent.
You read that right: A debt management program usually offers a lower monthly payment than what you’re paying now. So, you get some breathing room in your budget, too.
#3: It dramatically cuts how much interest you pay
One of the main goals of a debt management program is to reduce or eliminate interest charges from your debts. Data shows people who use the program typically see their rates reduced to between 0-11 percent. This can cut your total interest charges you pay by half or more. That saves you money as you repay your debt so you can use it on bigger and better things.
#4: You can get out of debt faster
A minimum payment schedule is not designed to be an effective way to eliminate debt. If you always make minimum payments, expect to be in debt for a few decades (no kidding). On the other hand, average payoff periods on a debt management plan range from 36 to 60 payments. In other words, you can be out of debt in less than five years.
So you can get out of debt for less money each month, less money total and faster. The reason? This type of program lets you pay off your debt in a more efficient way. You reduce or eliminate interest charges, so more of each payment you make goes to pay off principal; that’s the original debt you owe. As a result, you can get out of debt faster, even though you pay less each month.
#5: This can stop penalties and collections
Falling behind on your debt payments creates lots of financial stress. Not only do you worry about catching up, you face steep penalties every time you miss a payment. That stress gets even worse if the creditor writes off your debt and it goes to collections. Then you have to deal with constant phone calls and harassment by collectors.
Enrolling in a debt management program stops future penalties on your credit accounts. The creditor agrees to stop them when the credit counseling agency calls to negotiate your interest rate. If they agree to let the agency include their debt in your program, then your adjusted payment counts as the monthly payment you’re required to make each month. So, no new penalties can be added.
In addition, this can also stop collection actions. If you have debts that were already written off that you want in include in your DMP, your counseling team will contact those collectors. They can agree to allow the agency to include the collection account in your DMP. In which case, those annoying collection calls will stop. Plus, if a collector calls, you can simply refer them to the credit counseling agency. They deal with collectors on your behalf.
Debt management cons
#1: This freezes any account you include in the DMP
Once you enroll and the creditor agrees to the adjusted payment schedule, they immediately freeze your account. That means you can’t make any new charges on your account until you complete the program. This can be tough if you’ve come to rely on credit cards to cover parts of your monthly budget.
The good news is that with your payments reduced, you usually have an easier time staying on budget. You won’t need to juggle bills or choose which necessities you can pay for each month. However, you won’t have that instant gratification of using credit to purchase something you want when you see it.
The other bit of good news is that you don’t have to include all your accounts in the program. If you want to leave a card out for emergencies, you have that right. You can even add the account into your program later if you so choose.
#2: You can’t apply for new credit cards during enrollment
The idea with a DMP is that you stop making charges altogether while you eliminate your debt. So, not only are the accounts you include frozen, you can’t apply for new credit cards either. If you do, you can expect a rejection letter.
This does not apply to any closed credit line financing. This means you can still apply for loans during your enrollment and get approved. If you need a mortgage or auto loan, you can get it. You can even apply for private student loans if you want to go back to school. It only applies to open unsecured credit lines, which largely refers to credit cards.
#3: There is a slight risk of credit damage when you start the program
Overall, a debt management program is supposed to have a positive or neutral effect on your credit. Since you pay back everything you borrowed, you don’t get penalized like you do for debt settlement programs. In fact, many people who enroll see their credit scores improve once they complete the program. You pay back what you borrowed and if you stick to the payment schedule you build positive credit history, too.
However, some people who enroll experience a credit score decrease right at the beginning of the program. That’s not because the program damages your credit. It’s because the enrollment process wasn’t explained fully, so payments can get missed. Here’s the catch:
- When you sign up for a debt management program, you and the credit counselor set up a repayment plan that works for your budget.
- They send you paperwork to sign that authorizes the agency to work on your behalf.
- However, you signing up for the program is not the last step in the enrollment process! The agency must call each of your creditors and get them to agree to the adjusted payment schedule.
- So, while they’re getting all your creditors to agree, your program hasn’t technically started yet.
- That means you must continue to make the minimum payments on your accounts UNTIL all your creditors sign off and your program starts.
- Then you stop making payments to your creditors and start making the one consolidated payment to the counseling agency.
This is where DMP credit damage usually occurs. The credit counselor doesn’t fully explain how the setup process works, so people assume they can just stop making payments. Then they get missed payment notifications from their creditors and think they got scammed.
The true credit advantages of a debt management program
When a program is explained fully and executed correctly, this credit damage doesn’t occur. Again, at worst the program should have a neutral effect on your credit score, meaning your score wouldn’t change. Most people typically see their scores improve with program completion.
The credit effect really depends on where your score was when you enrolled. If you had bad credit (like a 500 FICO score) when you started, then your score will usually increase. Eliminating your credit card debt improves your credit utilization ratio, which accounts for 30% of your credit score calculation. You also build a positive payment history, which accounts for 35% of your score calculation. Improving those two main factors will boost a bad credit score.
However, if you had excellent credit score when you started, then you don’t have much room for improvement. If you already have a 750 FICO, you don’t have much room to grow beyond that. The positive payment history doesn’t have such a great impact. Dropping your utilization ratio to zero might boost your score a few points, but it won’t be a huge jump.
This means if you’ve managed to maintain excellent credit while you struggle to pay off your debt, consider enrollment carefully. An excellent credit score means you may be better off using a DIY option, like a debt consolidation loan. With that, there’s no risk of credit damage unless you don’t make the payments. But you don’t have to worry about an enrollment period where things can go wrong.
If you decide you still want to use a DMP, just monitor the enrollment process carefully. Continue making all your minimum payments until the credit counseling agency tells you that you can stop. And if you have bad credit, don’t worry about DMP enrollment – you can’t exactly fall off the FICO credit floor.
Article last modified on September 22, 2017. Published by Debt.com, LLC . Mobile users may also access the AMP Version: Debt Management Program Pros and Cons - AMP.