Everything you need to know about debt management plans

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If you’re deeply in debt and don’t know how to get out of the hole, a debt management plan…

If you’re deeply in debt and don’t know how to get out of the hole, a debt management plan could provide you with a lifeline. By working with a credit counselor, you can design a plan that lowers the interest rate on your debt, gives you a path to repayment, and streamlines payments.

“There are few downsides to a debt management plan, especially compared to other options, like debt settlement or bankruptcy,” says Amy Maliga, financial educator at Take Charge America, a non-profit credit counseling and debt management agency.

Here’s how debt management plans work to help you decide if a DMP might be right for you.

[Read: Best Low-Interest Credit Cards.]

What is a Debt Management Plan?

A debt management plan from a nonprofit credit counseling agency consolidates your unsecured debt into one affordable monthly payment to pay off what you owe in three to five years. You make a payment to the credit counseling agency, which distributes the money each month to your creditors.

Although these plans are offered by non-profit organizations, they are not free. A debt management plan may have setup fees and monthly fees.

“While nonprofit agencies offer their counseling services for free, most debt management plans are fee-based,” says Allison Wetzeler, certified credit counselor at Consumer Credit of Des Moines.

Fees can depend on your debt, budget and state regulations, but they’re usually “far lower than the interest you’ll save” on the plan, Wetzeler adds.

How a Debt Management Plan Works

The first step is to review your financial situation with a nonprofit credit counselor before agreeing to a debt management plan. This will help the counselor design a plan that meets your needs.

Generally, a DMP does not reduce the amount of debt you owe. But the credit counseling agency will likely negotiate with your creditors to increase the time you have to pay off the debt, which lowers your monthly payments. Your creditors may also agree to lower your interest rate or waive certain fees.

Only unsecured debt can be included in a debt management plan. Some of the debts that could be part of a debt management plan include:

Credit card statements.

– Medical bills.

Personal loans.

A debt management plan can take up to 48 months or more, according to the Federal Trade Commission. However, payment terms can be much shorter in some cases, says Maliga.

“Most people on these plans can pay off their credit card debt in full in five years or less,” she says. “Many pay it off in as little as two years.”

You may not be able to apply for credit while the plan is in place, the FTC says.

If you sign up for a debt management plan, you need to transition from using credit regularly to a cash-only lifestyle, Maliga says. “It can be difficult at first, but breaking the credit card habit and only spending what you can afford is a key concept to living a debt-free life,” she says.

[Read: Best Balance Transfer Credit Cards.]

How to enroll in a debt management plan

Start by identifying a reputable nonprofit credit counselor. Find candidates through the National Foundation for Credit Counseling and the Financial Counseling Association of America, and check their reputation with your attorney general or the Better Business Bureau.

Some questions to ask to find the best credit counseling service, according to the Consumer Financial Protection Bureau: Do you offer in-person counseling? Do you have free teaching materials? What fees do you charge? Do you provide help if someone can’t afford the fee? Is your organization licensed in this state?

Choose carefully. The FTC warns that some nonprofit credit counseling agencies charge high fees and that these costs may be hidden.

Don’t agree to a debt management plan unless you’ve spoken with a credit counselor about your financial situation and worked out a plan to deal with your money troubles, says the FTC.

You’ll speak with an advisor in person, over the phone, or online. Prepare by reviewing your credit reports — you can always access them for free online — and making a list of your debts.

Advantages and disadvantages of debt management plans

Advantages

— Save money if your debt management plan lowers your interest rate and waives fees.

— Repay the debt generally within five years.

— Make one payment to the credit counseling agency instead of multiple creditors.

— Causes less damage to your credit than with debt settlement or bankruptcy.

The inconvenients

— You may lose access to credit cards until your debt is paid off.

— Some creditors do not participate in debt management plans.

— You cannot include debts secured by collateral, such as your house or car.

— You may not be able to take out new credit on the plan.

Does a Debt Management Plan Affect Your Credit?

A debt management plan might hurt your credit in the short term, but help it in the long term. You may need to close accounts as part of a debt management plan, which can affect your credit.

“This can cause your credit score to drop slightly,” says Wetzeler. “However, most people are seeing an increase in their scores as creditors will continue to report monthly payments on time.”

At the end of a debt management plan, consumers generally emerge in a much stronger position, Maliga says.

“Many clients finish their debt management plans with their credit in good shape to buy a home or achieve other financial goals,” she says.

You can build a positive payment history, a strong credit rating factor, and pay off your accounts in full.

Alternatives to a Debt Management Plan

If you decide that a DMP won’t work, consider one of these alternatives:

Debt consolidation loan. This type of loan consolidates several debts into a single fixed amount. A debt consolidation loan can make sense if the interest rate is lower than what you’re paying on your individual debts, says Wetzeler.

Debt snowball method. Wetzeler and Maliga both love the debt snowball method, in which you pay off debts from smallest to largest. Once the smaller debt is paid, you apply the funds you were spending on that debt to the next smaller debt and repeat.

Debt avalanche method. This is similar to the snowball method, except you start by paying off the card with the highest interest rate, working your way down to the card with the lowest rate, Maliga says. “Both methods can be effective, but people need the motivation and discipline to stick to those plans and not keep using their credit cards while they work to pay off their debts,” she says. .

Debt settlement. You may consider negotiating with your credit card companies to settle for less than you owe. A lawyer or debt settlement company can also negotiate but will charge a fee and you may owe taxes on the paid debt. Settlement can hurt your credit and is considered a last resort before bankruptcy.

[Read: Best Credit Cards for Bad Credit.]

Is a debt management plan right for you?

Debt management plans are not for everyone. But for some people, they can be the key to breaking the cycle of debt. Wetzeler points to the best candidates for a debt management plan:

Paying high interest on credit cards. “You don’t have to be late or late to qualify for a DMP,” she says.

Juggle multiple creditors. A debt management plan makes sense if you want to consolidate so you only have one payment per month.

Have reached the maximum or approached their credit limits. “Maximizing your credit card increases your credit utilization rate, which is one of the most important factors in your credit score,” says Wetzeler. Financial experts recommend keeping the ratio – the percentage of total available credit you use – below 30%.

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Everything you need to know about debt management plans originally appeared on usnews.com

Update 08/12/22:

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