Debt Consolidation vs Debt Management: Which Makes More Sense for You?

Debt Consolidation vs Debt Management: Which Makes More Sense for You?

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If you're looking for a way to start paying off your debt, you may have seen information about debt consolidation loans and debt management plans. These options may help you pay down or control your debt and are relatively easy to understand.

Debt Consolidation or a Debt Management Plan: Which Makes More Sense?

Choosing between a debt consolidation loan and a debt management plan is usually a pretty straightforward process, but it's a good idea to investigate both options and determine what's best for you.

In general, a debt consolidation loan is usually your best bet if you don't have problems making monthly payments, you have a manageable amount of debt and you just want to pay a lower interest rate. If you can pay off your debt quickly, a promotional 0% APR balance-transfer credit card could result in paying no interest at all. When you take out a debt consolidation loan, your debts will still be marked as paid as agreed, which shouldn't affect your ability to get additional credit if you need to take out a car loan or mortgage while you're repaying your debt consolidation loan. At the same time, the newly available credit could tempt you to run up your balances again, which puts you in a worse financial situation.

On the other hand, if you're struggling to make your monthly minimum payments or you have a large amount of debt, a debt management plan may be the better option for you. The lower interest rates and fees that credit counseling agencies can negotiate, along with the typical three- to five-year repayment period, often results in more money going toward paying down your debt and less money going toward interest payments.

The debt management plan will require you to close all credit accounts—in limited situations, you may be allowed to keep one credit card for business or emergency expenses—and depending on which credit counseling organization you work with, you may not be allowed to open new accounts. Even if you can, a lender may not grant you credit as the debt management plan will be marked on your credit report and indicates to the lender that you’ve had previous financial difficulty. In some cases, a debt management plan could affect your credit score as some creditors may mark your account as not paid as originally agreed even though they are accepting reduced payments from you. However, a debt management plan will usually result in a net increase to your credit score, provided you follow the plan.

In some cases, neither a debt management plan nor debt consolidation loan is the right solution. You may want to consider other options if you owe more than your annual income in the form of "bad" debt (e.g., high-interest credit cards or payday loans), you simply cannot make minimum payments on time, or a debt management plan can't reduce your monthly debt payment to a manageable amount.

What is Debt Consolidation?

With debt consolidation, you'll take out a single loan large enough to pay off all of the debt you need to consolidate. Ideally, the interest rate will be lower on the new loan. Then, you'll take the proceeds from that loan and pay off the other debts. After consolidation, you'll have fewer debt payments to keep up with each month and you'll save money in interest. If you're able to pay off the debt quickly, you may want to consider a promotional 0% annual percentage rate (APR) balance-transfer credit card. Some of these cards offer up to 21 months' of interest-free payments before the regular interest rate kicks in. If you need more time to pay off the debt, other common debt consolidation options include personal loans and home equity loans or lines of credit.

What is a Debt Management Plan?

Debt management plans are usually offered by credit counseling organizations or debt relief professionals. These plans work to repay your creditors in full over a three- to five-year period. The credit counseling organization will work with you and your creditors to negotiate a plan that will work for both parties. The debt management plan may result in reduced or waived interest rates and fees you would otherwise pay if you continued repaying your debt without the plan. You'll make a monthly payment to your credit counseling agency every month, and the agency will distribute the payment to all of your creditors. When you join a debt management plan, your accounts will typically be closed or suspended to prevent you from incurring more debt. Most credit counseling organizations will charge a setup fee and monthly fee to oversee your debt management plan.

Madison is a former Research Analyst at ValuePenguin who focused on student loans and personal loans. She graduated from the University of Rochester with a B.A. in Financial Economics with a double minor in Business and Psychology.