What is a debt management plan?
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- Credit counseling agencies offer debt management plans to help consumers pay off debt.
- Your credit counseling agency negotiates the terms of your debt with your creditor, lowering interest rates and other fees.
- Credit counseling is great for people with subpar credit and high-interest credit card debt.
Paying down debt is a common struggle with household debt rising to $16.9 trillion in the fourth quarter of 2022 over several different products including credit cards, personal loans, and mortgages. There are over a billion credit cards currently in circulation, which is over three times the entire US population.
There are myriad of solutions geared towards tackling this issue. You can find plenty of payment strategies such as the debt avalanche or snowball method, which focus on how to allocate your funds across multiple debts. Additionally, you can try consolidating your debt.
The best consolidation loans will get you a lower interest rate while simplifying your debts, but your rates will hinge on your credit score. However, if you don't have the credit score necessary to qualify for this, you may consider a debt management plan, which can provide relief in a grim financial situation.
Debt management plans explained
Debt management plans are a service that nonprofit credit counseling agencies offer their clients "that can help financially struggling consumers get out of debt and achieve financial stability," says Bruce McClary, nonprofit credit counselor and Senior Vice President of Membership and Communications of the National Foundation for Credit Counseling (NFCC).
In a debt management plan, a credit counselor negotiates with your creditor on your behalf. These negotiations are an attempt to secure lower interest rates and fee waives on your unsecured debt. They may also negotiate lower monthly payments in exchange for a longer payment period.
Once your debt management plan has been established, you'll make one monthly payment to your credit counselor, who'll distribute your payment to those creditors. Debt management plans usually take about four to five years to complete, according to McClary.
Nonprofit credit counseling agencies typically charge a small fee for this service. You'll pay a set-up fee ranging from $30 to $50 and a monthly maintenance fee from $20 to $70, according to Experian. However, a debt management plan can help you save money on interest in the long run.
While on a debt management plan, it's crucial that you make your payments each month. Missing a payment may cause your creditor to back out of the agreement. Missing several payments in a row will cause the credit counseling agency to terminate the plan.
Debt management plans pros and cons
A debt management plan is an excellent repayment tool if your debt is weighing you down and you need a credit counselor to provide guidance and keep you accountable. However, this program has its share of downsides to consider.
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Does a debt management plan affect your credit score?
The existence of a debt management plan will not directly affect your credit score, but your credit score may change as a result of any actions taken over the course of the debt management plan.
Closing credit accounts
As part of the debt management program, your credit counselor may ask you to close your credit accounts. Doing so can negatively impact your credit score if you close it with an outstanding balance on your account.
Additionally, if you shut down one of the longer-standing accounts on your file, it may have an impact on your length of credit history. It will also have an impact on your available credit, which can impact your credit utilization ratio.
Building positive payment history
One of the perks of a debt management plan is that you only need to make a single payment, making paying your debt more manageable so you're less likely to miss a due date. Debt management plans can also lower your monthly payments which can be helpful if you're struggling to come up with the funds each month, making a credit delinquency less likely.
Lowering credit utilization
As you pay off your debt, specifically on your revolving credit accounts, your credit utilization ratio will lower. You generally want to keep this ratio under 30%, though the lower you can keep your utilization ratio, the better your credit score will be.
Is a debt management plan right for you?
A debt management plan may make sense if you're struggling to manage debt, particularly unsecured debt. "Generally, DMP's may be a good fit for individuals with high-interest credit card debt who are at risk of falling behind with payments," says McClary.
On the other hand, he sas that those with good credit and less trouble managing their debt may opt out of a debt management plan. Instead, they should consider a low-interest debt consolidation loan or a balance transfer credit card. Learn more in Insider's guide to the best balance transfer credit cards.
Additionally, a debt management plan may not be suitable for you if you don't have unsecured debt because debt management programs won't cover secured loans.
"Collateralized debt such as auto loans and mortgages cannot be included," says McClary. "Ultimately, the decision on which option to choose should be based on individual circumstances and guidance from a nonprofit credit counseling agency."
Debt management plan frequently asked questions (FAQ)
What does a debt management plan do?
A debt management plan lowers your interest rates and simplifies your debts into a single monthly payment. You'll give this payment to a credit counselor who distributes the money among your creditors.
Is it good to have a debt management plan?
A debt management plan may be worthwhile if you struggle to pay off unsecured debt like credit card debt, medical bills, and personal loans. It's an especially good idea if your debt makes up a significant portion of your annual income.
What are the negatives of a debt management plan?
A debt management plan may only be ideal for some. This program only works for those who need help paying off unsecured debt instead of collateralized debt. Additionally, you'll have to pay an upfront and monthly fee for this service.
Can I do a debt management plan myself?
Yes, you can create a debt management plan yourself. You can negotiate interest rates and fees directly with your creditors, though results will vary depending on your credit profile. There are also debt management apps like Tally that will automatically distribute a single payment across multiple debts.