Everything You Need to Know About Debt Management Plans – WTOP | Vette Leader

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

If you’re heavily in debt and don’t know how to get out of the hole, a debt management plan could be a lifeline. Working with a loan advisor, you can design a plan that will lower the interest rate on your debt, give you a path to repayment, and streamline payments.

“There are few downsides to a debt management plan, especially when compared to other options like paying off debt or bankruptcy,” says Amy Maliga, financial educator at Take Charge America, a nonprofit 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 a single affordable monthly payment to pay off your debt in three to five years. You make a payment to the credit center, which distributes the money to your creditors each month.

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

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

Fees may depend on your debt, budget, and regulations in your state, but they’re usually “far less than the interest you 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 any debt management plan. This will help the counselor design a plan that suits your needs.

Typically, a DMP does not reduce the amount of debt you owe. But the credit bureau will likely negotiate with your creditors to extend the time you have to pay off the debt, lowering 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 debt that could be part of a debt management plan include:

— Credit card statements.

— medical bills.

– Personal loans.

According to the Federal Trade Commission, a debt management plan can take up to 48 months or more to complete. However, withdrawal times 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 just two years.”

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

Signing up for a debt management plan requires you to transition from using credit regularly to adopting a cash lifestyle, says Maliga. “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 debt-free,” she says.

[Read: Best Balance Transfer Credit Cards.]

How to sign up for 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 personal advice? Do you have free teaching materials? What fees do you charge? Do you offer help if someone cannot afford the fees? Is your organization licensed in this state?

Choose wisely. The FTC warns that some nonprofit credit counseling agencies charge high fees, and that these costs can be hidden.

Don’t agree to any debt management plan unless you’ve discussed your financial situation with a credit counselor and worked on a plan to manage your money problems, the FTC says.

You speak to an advisor in person, by phone or online. Prepare by checking your credit reports — you can still access them online for free — and making a list of your debts.

Pros and cons of debt management plans

advantages

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

— Usually pay off the debt within five years.

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

— Do less damage to your credit than a debt settlement or bankruptcy.

Disadvantages

— 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 debt secured by collateral, such as your home or car.

— You may not be able to add new credit to the plan.

Does a Debt Management Plan Affect Your Credit Score?

A debt management plan could hurt your credit in the short term but help it in the long run. You may have to close accounts in a debt management plan, which could affect your credit score.

“This can result in a small drop in your credit score,” says Wetzeler. “However, most people will see their score increase as creditors will continue to report on-time monthly payments.”

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

“Many clients end their debt management plans with good credit to buy a home or meet other financial goals,” she says.

You can build a positive payment history, an important factor in creditworthiness, and pay back your accounts in full.

Alternatives to a debt management plan

If you decide that a DMP isn’t working, consider one of the following alternatives:

Debt Consolidation Loan. This type of loan combines multiple debts into a single fixed amount. A debt restructuring loan can make sense if the interest rates are lower than the individual debts, says Wetzeler.

Debt Snowball Method. Both Wetzeler and Maliga like the debt snowball method, where you pay off debts from the smallest to the largest. Once the smallest debt is paid, apply the funds you spent on that debt to the next smaller debt and repeat the process.

method of debt avalanche. This is similar to the snowball method, except you start by paying off the card with the highest interest rate and work your way down to the card with the lowest interest rate, says Maliga. “Both methods can be effective, but people need the drive and discipline to stick to those plans and stop using their credit cards while they work to pay off the debt,” she says.

debt settlement. You may consider negotiating with your credit card companies to settle with less than what you owe. An attorney or debt settlement company can also negotiate, but they will charge fees and you may owe taxes on debt forgiven. A settlement can damage your creditworthiness 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 aren’t for everyone. But for some people, they can be the key to breaking the cycle of debt. Wetzeler says the best candidates for a debt management plan:

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

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

Have reached or approached your credit limits. “When you max out your credit card, your credit utilization rate increases, which is one of the most important factors in determining your creditworthiness,” says Wetzeler. Financial experts recommend keeping the ratio — the percentage of total available credit you use — under 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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