How Do Debt Management Plans Work? Should You Enroll in One?

How Do Debt Management Plans Work? Should You Enroll in One?

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If you're struggling with your debt and just can't figure out how to make the numbers in your budget work, you may want to consider contacting a credit counseling agency. One program many credit counseling agencies offer is a debt management plan, which could be the solution you've been looking for to help you solve your debt problem.

What is a Debt Management Plan?

A debt management plan is a way to repay unsecured debt, such as credit card and personal loan debt, and it's usually offered as a program through credit counseling agencies. Unfortunately, debt management plans won't work with all types of debt. Secured debts, like mortgages and car loans, do not qualify for debt management plans. Neither do certain types of unsecured debt such as student loans. In the middle, there are some types of debt, including medical debt, which may or may not qualify for debt management plans. That said, you normally must include all debt that qualifies if you do enroll in a debt management plan.

Credit counseling agencies work with you to get a picture of your entire financial situation, including information on every debt you owe. After gathering the necessary information, the credit counseling agency will work with your creditors to come up with a repayment plan that will work for everyone. Usually, creditors can reduce interest rates, lower monthly payments and sometimes waive fees, but it is important to note that creditors will rarely reduce the balance you owe on each debt.

Once a plan is formed, you'll be responsible for one monthly payment to your credit counseling agency. The agency will then distribute the money to each creditor according to the plan. The amount of time you'll be in the debt management plan may differ with each plan, but most require you to make monthly payments for three to five years. It is extremely important that you make every debt management plan payment on time. Making late payments could allow creditors to opt of out of the debt management plan, which could mean you'll revert to the much higher interest rates and fees that you were trying to escape in the first place.

When you enroll in a debt management plan through a credit counseling agency, you usually aren't allowed to apply for any new credit during the length of your plan. Additionally, most creditors will require you to close your accounts so you can no longer make new purchases on them. Some debt management plans do allow you to keep one credit card open for emergencies, business expenses or travel purposes, but others require you to close all accounts.

Enrolling in a debt management plan will affect your credit, but the impact on your credit will differ depending on your specific situation and credit history. A note will be placed on your credit report stating you are taking part in a debt management plan, but it should be removed after the program is completed. This note will not affect your credit score, but other actions will affect your score.

When it comes to your FICO score, four of the five major scoring factors will probably be impacted.

  • Payment history (35%): Making on-time payments each month should help your score.
  • Amounts owed (30%): Your score should improve as your debt management plan decreases the amounts you owe with each payment.
  • New credit (10%): Since you won't be applying for new credit, you shouldn't have any inquiries that would lower your score.
  • Credit history length (15%): Due to closing your accounts when you start a debt management plan, this portion of your score will likely suffer.
  • Credit mix (10%): This portion of your score will depend on your mix of credit prior to and after entering the debt management plan.

While credit counseling agencies are there to help you, they usually charge an upfront fee to start a debt management plan as well as a monthly fee while you are enrolled in the program. The fees are usually less than $50 upfront and less than $40 on a monthly basis, but they vary from agency to agency and depending on your specific situation. Even after accounting for the fees that agencies charge, you should still end up saving money with the reduced interest rates that the counselors negotiate with your creditors.

When Does a Debt Management Plan Make Sense?

Enrolling in a debt management plan will most likely help you pay your debt off faster while paying less interest at the same time. During the repayment period, you'll learn to live off of less than you earn without incurring more debt, since you won't be able to open new credit accounts. When your debt management plan is paid off, hopefully your habit of racking up new debt will be vanquished—leaving you with a new, responsible financial mindset going forward.

At the same time, a debt management plan can put a damper on your plans. Once you enter a debt management plan, you won't be able to take out debt to purchase a car or a home. Instead, you'll have to wait until the debt management plan is complete or you may face penalties from creditors that agreed to your debt management plan. While this isn't always a bad thing, since it helps you live within your means, it can delay plans you had for your future.

Debt management plans can help many people get their bad debt habits under control, but they aren't a one-size-fits-all solution. If you're juggling multiple credit cards and getting behind on your payments, a debt management plan could be just what you need to get back on track. However, it may not be the answer if you have so much debt there is no hope of paying it back on your income. A credit counselor should be able to help you determine which situation you're in based on a thorough look at your finances. If you're too far in over your head, you may need to consider other options, which a good credit counselor can help you identify.

On the other hand, if you know your debt is getting a bit out of control but you have no issues making the monthly payments, there are plenty of ways you can handle the situation yourself without enrolling in a debt management plan. You could consider a debt consolidation loan to lower the interest rate on your unsecured debt.If you're afraid you'll just run up your credit card balance again, then you can close your newly paid-off credit lines so you won't fall into the same trap again.

How to Find a Reputable Debt Management Plan

Finding a debt management plan through a reputable credit counselor requires a bit of research. Not all credit counseling agencies will have your best interests in mind. Some agencies are for-profit businesses, which may put their interests ahead of your own. Even some nonprofit agencies may not provide you with the best advice or debt management plan for your situation.

To find a reputable credit counseling agency, first look into the ones in your area. They should give you information about their services for free without requiring information about your financial situation. Then look for reviews from former clients and check reports from the Better Business Bureau. Check whether each agency and its counselors are licensed to offer services in your locality and associated with professional organizations such as the National Foundation for Credit Counseling.

Once you narrow the list of agencies you are considering, speak with each agency about the counseling options they provide. Make sure they will consider options besides debt management plans, as they may not always be the best solution for your situation. In fact, if an organization seems to be pushing you into a debt management plan before you even discuss your financial situation with them in detail, you should be very wary.

Once you pick a credit counseling agency, you'll meet with a credit counselor to go over your financial situation. You'll need to provide information about your income, expenses and assets. Bring information on all of the debts you owe, including the creditor and contact details, the amount you owe, the interest rate on the debt and the monthly minimum payment required. Bring the loan paperwork if you have it. While some of the information can be found on a credit report, other information will either need to be pulled from the credit agreements or obtained from the creditors directly.

After a thorough review of your financial situation, the credit counselor should give you options and recommend a plan that they feel will work best for your situation. You do not have to accept the plan, so be sure to think it over. Read through the contract to make sure you understand everything. Make sure everything that was promised verbally is in writing in the contract—or else it likely won't be enforceable.

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.