What Is A Debt Management Plan? (2024)

Being able to borrow money to make important purchases can help dreams come true, but, if payments on debts become more than you can manage, the situation can become more like a nightmare.

One way out of this unpleasant scenario is with a debt management plan prepared and implemented with the help of a consumer credit counselor.

What Is a Debt Management Plan?

A debt management plan lets you make a single monthly payment that covers all of your unsecured debts that are included in the plan. It’s not a loan and it won’t allow you to pay less than you owe, but a debt repayment plan can simplify the repayment process and shorten the time it takes you to get out of debt.

Role of Credit Counseling Agency

The key player in a debt management plan is a consumer credit counseling agency. Many of these are nonprofits, the best of which offer financial education and counseling by trained and certified personal finance counselors. However, simply because an agency claims nonprofit status does not mean that the agency is right for you. Do your research to help ensure the agency is a legitimate one and that any fees will be affordable. Many states require consumer counseling agencies to be licensed as well.

A reputable consumer counseling agency will provide free information about the services it offers. These services should include, in addition to debt management plans, help with setting up a budget and otherwise mastering financial literacy. Most agencies offer services in person, online and via telephone.

Consumer counseling agencies charge fees for their services. These fees are generally modest and should be set out in writing. An agreement with a credit counseling agency, including any oral promises made by a counselor or other representative, should be put in writing. There should be no pressure on a prospective client to sign an agreement immediately or without taking adequate time to read and consider the agreement.

The role of the consumer counseling agency is, first, to understand the client’s individual situation. The counselor will help the client develop a budget. Part of this budget will be a plan to repay the client’s unsecured debts, such as credit cards and personal loans.

The agency will also negotiate with creditors. The counselor will attempt to get the creditors to waive late fees and begin charging lower interest rates on the debt.

The agency will automatically draft the agreed-upon monthly payment from the client’s bank account. From that amount, the agency will pay all creditors who are part of the plan.

Features of a Debt Management Plan

A debt management plan often includes agreements by creditors to waive late fees for prior missed payments and also to reduce interest rates on outstanding balances. A typical result might be reducing an interest rate from 20% or more to less than 10%.

The debt management plan generally aims to pay off all the unsecured debts within three to five years. Four years is a typical time to complete payoff. Debt management plans are only for unsecured debts such as credit cards and personal loans. They don’t include mortgages, auto loans and other debts secured with collateral. They also are not for student loans.

While the debt management plan is in operation, the client will be required not to apply for any new credit cards or other loans. It’s also important that all monthly payments to the agency be made in full and on time, so the creditors can be paid as scheduled. Otherwise, the creditors may reinstate late fees and start charging higher interest rates.

Debt Management: How to Enroll

Before enrolling in a debt management plan, a borrower should review his or her situation, including adding up sources of income and making a list of debts that are owed. This helps you better understand your options and, as a bonus, you’ll be prepared when the credit counselor asks for the same information.

Next, identify a reputable credit counselor. You can check with one of the national organizations for nonprofit credit counselors, such as the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA), to find suitable candidates. You can further check agencies with your state attorney general or the Better Business Bureau.

An agency typically will start with a one-hour initial counseling session, during which you’ll share details of your financial situation and the counselor will help you prepare a personal debt repayment plan. You may also have follow-up sessions. The agency will also likely offer financial education classes on budgeting and similar topics.

The counselor will contact the creditors you plan to pay off and try to negotiate fee waivers and lower interest rates. You’ll agree to pay the agency a flat monthly amount, which the agency will parcel out to your creditors.

The agency will also charge you a setup fee plus a monthly fee for the debt management service. The setup fee will usually be less than $75. The monthly fees may be a percentage of the monthly payment or a flat amount. A typical monthly fee will be less than $50. You may be able to negotiate a reduced fee or waiver if you are experiencing severe financial stress.

You’ll be asked to sign a contract specifying how much you’ll pay and what the agency will do with the money. You’ll also have to agree not to open any new credit cards during the debt management plan’s term. When the last payment is made, in three to five years, you’ll have paid off all the unsecured creditors covered by the plan.

Pros and Cons of Debt Management

Enrolling in a debt management plan can help a deeply indebted borrower become debt-free, but it has some costs, risks and limitations as well. Here are the advantages and disadvantages of debt management plans.

Advantages

• One automatic payment to multiple creditors
• Lower monthly payment to service debts
• Faster elimination of debts
• Accountability and oversight by agency
• Budgeting and other financial education
• Possible waiver of late fees and other charges
• Possible lower interest rate
• No long-term negative credit score impact
• Fewer dunning calls from creditors

Disadvantages

• Won’t help with secured debts
• Some creditors may not accept plan
• Counseling agency charges fees
• Must stay current or risk voiding plan
• Risk of encountering fraudulent agency
• Requires three to five years to pay off debts
• Can’t get new credit cards or other loans during the term of the plan

Other Debt Relief Options

Debt management plans can be powerful remedies for some debtors, but they aren’t for everyone. For instance, a borrower needs sufficient income to make the required monthly payments or the debt management plan will not be successful.

With that in mind, the counselor should suggest other options if a debt management plan is not the right approach for an individual borrower. Options for debt relief include debt consolidation, debt settlement or filing for bankruptcy.

Debt Consolidation Loan

Taking out another loan and using the proceeds to pay off other credit cards or loans can be an effective, low-cost way to make debt more manageable and, eventually, pay it off. Debt consolidation loans are best for borrowers who have good credit, as well as the income to make the payments on the new loan.

Options for debt consolidation loans include personal loans, home equity loans and balance transfers to lower-rate credit cards. Home equity consolidation loans can be risky because, if the borrower can’t make the payments, he or she could lose the home securing the loan.

Debt Settlement

Debt settlement is a more radical approach to handling indebtedness. It’s usually offered by for-profit companies that promise to negotiate with your creditors and convince them to accept a lump sum payment that is less than the amount you owe. You’ll be asked to deposit money every month into an escrow account to accumulate that lump sum. The debt settlement company will charge you fees for its services.

This approach is generally considered to be riskier than debt management. It may take years to accumulate the necessary lump sum. Meanwhile, debt settlement companies often advise clients to stop making payments to creditors, which can have a negative effect on your credit score.

Debt settlement, which may also be referred to as debt elimination or debt relief, is a field plagued with dishonest companies that may attempt to get you to pay large fees before settling any of your debts. It’s best to carefully investigate any debt settlement provider before signing up.

Bankruptcy

If you don’t have enough income to have a reasonable hope of paying off your debts, bankruptcy may be the best option. Bankruptcy is a legal process that results in a court order saying you won’t have to repay some of your debts.

For personal bankruptcy, the two common filings are Chapter 7 and Chapter 13. Both require filing a case in federal court, paying court fees and paying attorneys’ fees. The consequences of bankruptcy are long-lasting. A bankruptcy can stay on your credit report for up to 10 years and make it difficult to get more credit, rent a home and even get a job.

Do-It-Yourself Debt Management

Most of the things a credit counseling agency can do for you, you can do yourself. This includes learning about budgeting and assessing your total indebtedness and income. You can also negotiate with creditors, although you may not do as well with getting fee waivers and interest rate reductions as an experienced, trained and certified counselor.

However, if you handle the negotiations yourself, you’ll save money on fees and have more flexibility than if you signed a contract for a debt management plan with a consumer credit counseling agency.

Bottom Line

Debt management plans can be effective ways to get out from under unsecured debts. They involve fees, commitment and some restrictions on your ability to use credit. They also typically take a few to several years to complete, and won’t help you with mortgages and other secured loans or student loans. Before signing up with a consumer credit counseling agency, check the company’s reputation and resources and make sure you wouldn’t be better off using another method of handling debt, such as a consolidation loan or even bankruptcy.

Frequently Asked Questions