You’ve dug yourself into a debt hole. Things such as credit card debt, student loans, medical bills – they’ve piled up faster than you could pay them off. Now collectors are calling and letters are arriving daily. You need a plan to pay this debt before it swallows you whole. Which option is better – a debt management program or debt settlement?
Both could help you pay off what you owe, but they work differently. As you compare these two methods, think about your specific situation. How much debt do you have and what types? What’s your income? Do you have assets? Every situation is unique. Understanding the pros and cons of each approach helps you make the best choice to become debt-free. Keep reading to learn more about debt management vs. a debt settlement program.
Why Paying Off Debt is Important When Budgeting
So why should you be in a rush to pay off your debt anyway? Here’re some benefits to having no debt:
Having Peace of Mind
Paying off your debt gives you freedom from that one monthly payment and interest charges. No longer owing money to creditors means less stress and worry in your life. Sleep better at night knowing those debts are gone for good.
Improving Your Cash Flow
When you pay off debt, the money that was once going toward payments and interest charges becomes available to spend on the things you need and want each month. Your available cash flow improves dramatically without the burden of debt payments.
Opens Doors to New Opportunities
Shedding debt and improving your cash flow also opens you up to new financial opportunities. You may now qualify for a mortgage or auto loan that was out of reach before. You have more flexibility to make major purchases or investments without debt payments holding you back.
Builds Financial Security
Paying off debt is one of the best ways to build financial security and stability. When you owe less money each month to creditors, you have a stronger financial foundation and safety net. There is less risk of falling behind on payments or defaulting on loans. You’re in a better position to deal with financial emergencies or job loss without debt payments draining your available resources.
How Does a Debt Management Plan Work?
So debt management plans (DMPs) are designed to pay off your unsecured debts by reducing your interest rates and monthly payments.
Most plans take 4-5 years to complete. The agency charges a small monthly fee, but it’s often less than the money you save. A DMP requires discipline to stick to the payment plan, but it can be a lifesaver. It stops collection calls, reduces interest charges, and helps you pay off debt faster. The main steps are:
Meet with a credit counseling agency for a free evaluation.
Provide details on your income, expenses, and debts to determine if you qualify.
If approved, the agency contacts your creditors to negotiate new terms.
Make one lower payment to the agency each month, which they distribute to creditors.
Continue making on-time payments each month until the plan is paid off (typically 4-5 years).
A DMP does show on your credit reports, but creditors view it more positively than bankruptcy. While it’s active, your accounts may show as “settled for less than the full amount.” Once completed, the accounts will show a zero balance. Your score may dip initially but should start to rebound as balances decrease and you make consistent payments.
What to Expect With Debt Settlement
Now that you understand debt management programs — what about debt settlement?
It Could Take Many Years
Debt settlement is not a quick fix. The process of negotiating with creditors and paying off reduced balances typically takes 4-5 years. During this period of time, you’re going to stop making payments to creditors and instead put money in a separate account to save up for settlement offers. This means your accounts may go into default, and creditors will likely call to try and collect payments. Stay committed to the process — the result is likely worth it.
Your Credit Will Be Impacted
Defaulting on your accounts and negotiating reduced payoffs will hurt your credit. Debt settlement could drop your credit score by 50-100 points or more. The impact lessens over time as accounts are settled and closed, but it may take several years to recover a good score. Be prepared for higher interest rates and more limited access to new credit during this period.
Fees and Interest Charges Will Accrue
Even though you stop making payments during debt settlement, interest charges and penalties could continue to add up. The total amount you owe could increase significantly, often by 15-50% or more over the time it takes to complete the program. Make sure any debt settlement company you work with is transparent about all fees so you understand the total cost before starting. Some charge some hefty upfront fees, while others take a percentage of the savings from settlement offers. Compare carefully.
Success Isn't Always Guaranteed
There is a chance debt settlement will not resolve all your accounts. Some creditors may refuse to negotiate or sue to recover the full amount owed. Debt settlement companies cannot guarantee they will be able to settle all of your debts, even if they claim a high success rate. Be prepared for some accounts to remain unsettled at the end of the program. The risks are lower if you work with a reputable company and are a good candidate for debt settlement, but there is always some level of uncertainty.
Working With a Nonprofit Credit Counseling Agency
A nonprofit credit counseling agency helps create a tailored DMP to pay off your debts. They evaluate your financial situation to determine if a DMP is right for you. If so, they negotiate with your creditors to reduce interest rates, waive fees, and create a consolidated monthly payment plan.
Lower Rates
Nonprofit credit counseling agencies have established relationships with many creditors. They leverage these relationships to advocate on your behalf and try to lower the interest rates on your credit cards and other debts. Lower rates mean more of your monthly payment goes toward principal, allowing you to pay the balance faster.
Consolidated Payments
A DMP consolidates your monthly debt payments into one lower payment that you pay to the credit counseling agency. They then distribute the funds to your creditors. This simplifies your payments and makes budgeting easier. The agency can get creditors to freeze or lower minimum payments during the DMP.
Other Benefits
Other benefits of working with a nonprofit credit counseling agency:
Education on better budgeting and spending habits.
Support and guidance from a credit counselor.
Possible faster payoff than on your own. The agency has experience optimizing payment plans.
Possible fee waivers. The agency may get creditors to waive certain penalty fees like over-limit or late fees.
A DMP with a nonprofit credit counseling agency could be an effective way to pay off debt while minimizing damage to your credit and finances. However, debt management may not be right for everyone. Talk to an agency to determine if it meets your needs and will help you become debt-free.
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