Debt Management Plans: What You Need To Know Before Using One

Credit counseling agencies use debt management plans to help you pay off your debt in three to five years. In setting up a debt management plan (DMP), the agency will work with your creditors on your behalf and roll your unsecured debts into one monthly payment.

By adhering to a DMP, you may avoid defaulting on your debt or declaring bankruptcy. You may also save money and time — not to mention feel less stress. Still, there are some downsides to consider before setting up a debt management plan.

What is a debt management plan?

A debt management plan can help you pay off certain kinds of debt if you can get lower interest rates. 

A debt management plan is a payment schedule that allows you to consolidate certain debts into one affordable monthly payment and pay down your debt over time, usually over three to five years. DMPs are created and managed by credit counseling agencies — nonprofit organizations that offer advice and actionable solutions to people who need help with budgeting and/or debt.

“Establishing a debt management plan with a credit counseling agency is similar to hiring a personal trainer for your money,” says Steven Kibbel, a Certified Financial Planner. “They lower interest rates, take the uncertainty out of managing several obligations and assist you in structuring your payments in a way that seems manageable.”

With a DMP in place, you’ll make one monthly payment to the credit counseling agency instead of paying creditors directly. The agency will then distribute the funds to your creditors on your behalf. Sometimes creditors let you pay off your debt at a lower interest rate if there’s a DMP in place.

However, debt management plans are generally not free. Most agencies charge a setup fee and monthly management fees (typically less than $75). The fee amount depends on state regulations, but you may be eligible for a fee waiver if you meet certain income qualifications.

In addition, not all kinds of debt qualify for debt management plans. DMPs are generally only available for unsecured debt, such as credit cards or personal loans. Despite these downsides, the benefits of setting up a DMP may still be worthwhile for many people. As Kibbel says, “When you’re feeling overwhelmed, having an expert on your side provides much-needed peace of mind.”

How does a debt management plan work?

To set up a debt management plan, you’ll meet with a counselor online, in person or over the phone. Your counselor will review your credit reports and bills. They’ll also help you create a budget and discuss your payment options.

If you agree a DMP is the best choice for you, the counselor will contact your lenders and try to negotiate your loan terms. For example, your credit card issuers may agree to lower your interest rates, waive fees or reduce the amount you owe.

Each month, you’ll make a single payment to the credit counseling agency. This payment may include your monthly fee for the service. Overall, your monthly payment should cost less than what you entered the plan with.

Choosing a debt management plan: Pros and cons

Debt management plans can be helpful to many people struggling to pay off massive debt balances. However, they aren’t the best solution for everyone.

Types of debt management companies

DMPs are offered by nonprofit and for-profit companies. Many nonprofit agencies offer the lowest costs for DMPs and are usually considered trustworthy, according to the Federal Trade Commission. Still, it’s crucial to shop around, compare costs and read reviews like you would with any other financial service.

Nonprofit debt management companies

Typically, debt management plans are created by nonprofit organizations accredited by associations, such as the Financial Counseling Association of America (FCAA) or the National Foundation for Credit Counseling (NFCC). These companies offer services for free or at a low cost, and in addition to creating DMPs, they also offer educational tools and additional services or resources to help you rebuild your credit and budget better.

For-profit debt management companies

In addition, some for-profit agencies offer assistance with debt repayment. However, because these companies have an eye on the bottom line, their services tend to be more expensive than what you’ll find with a nonprofit.

It’s also more common for for-profit debt management companies to offer debt settlement plans rather than DMPs. With a debt settlement plan, the company will negotiate a lump sum payment with your creditors that is lower than your current outstanding balance.

With a debt settlement plan in place, you’ll typically skip making your monthly bill payments and instead deposit funds in an escrow account the company manages. The company will then use the funds in the account to try to negotiate lower one-time payments with your creditors.

How to choose between debt management companies

Selecting a reputable debt management company requires thorough research. Here’s what to look for when establishing a debt management plan:

• Check accreditation: Ensure the company is accredited by recognized bodies such as the FCAA or the NFCC. Accreditation helps verify that the company adheres to high industry standards.
• Look for nonprofit status: Many trustworthy debt management services are nonprofit organizations that focus on helping consumers rather than making a profit. However, this doesn’t guarantee low fees or reputable service. 
• Read reviews and testimonials: Look for customer reviews on trusted websites such as Trustpilot. Pay attention to how previous clients rate the company’s customer service and success in lowering debt.
• Understand fees and services: Be cautious of any company that charges excessive upfront fees or makes unrealistic promises. A reputable service should provide a clear breakdown of fees and offer a free consultation.
• Verify with state and federal regulators: Some states require debt management businesses to be licensed. Check your state’s Attorney General office or the Consumer Financial Protection Bureau (CFPB) database for any complaints or regulatory actions against the company.

Debt management plan alternatives

If a DMP doesn’t seem like the right fit, you can look into alternatives based on your financial situation. Each option comes with its benefits and drawbacks:

• Debt consolidation loans: This involves combining multiple debts into a single debt consolidation loan with a lower interest rate. Debt consolidation simplifies your payments but may require good credit to secure favorable terms.
• Balance transfer cards: You can save on interest by transferring high-interest credit card debt to a balance transfer card with a low or 0 percent introductory interest rate. However, there are typically balance transfer fees, and high interest may apply if the balance isn’t paid off within the promotional period. However, these often require excellent credit.
• Chapter 7 bankruptcy: Chapter 7 bankruptcy provides a fresh start by liquidating certain assets to eliminate most unsecured debts. It can significantly impact your credit but offers a quicker resolution to severe debt issues.
• Chapter 13 bankruptcy: Chapter 13 bankruptcy allows you to keep assets while repaying debts through a structured plan over three to five years. While it can protect you from foreclosure, it also negatively affects your credit and requires consistent payment for years.

Each of these alternatives has implications for your credit and financial future, so consider them carefully before deciding.

Bottom line

A DMP can help you consolidate your debt into a single payment, reduce your interest rates and lower your monthly payments. If a DMP seems like a good option for managing your debt, evaluate who you decide to work with.

To select a reputable agency, check its ratings on trusted review platforms and see what previous clients have said about their experiences. Try to find a DMP that aligns with your financial goals and budget, which will increase the likelihood of successful debt repayment.

Frequently asked questions

• Will a debt management plan affect my credit score?
  

  A DMP itself doesn’t directly impact your credit score. However, creditors may report that you’re on a DMP, which could affect your ability to obtain new credit during the repayment period. Initially, your credit score may dip, as some accounts may be closed as part of the DMP. Your score will improve as you consistently use good credit practices like reducing your debt and making payments on time.

• What are the costs associated with setting up a debt management plan?
  

  Most credit counseling agencies charge a small setup fee and monthly administrative fees for managing a DMP. These fees vary but are typically around $25 to $50 monthly. Nonprofit agencies may offer reduced fees for low-income individuals or waive fees based on financial need.

• What types of debt can be managed with a DMP?
  

  DMPs are designed to help manage unsecured debts, such as credit card balances, personal loans, medical bills and store card debts. However, secured debts like mortgages and car loans are not eligible for a DMP. Student loans, tax debts and other obligations are typically not covered. Check with your credit counseling agency to see which debts qualify for inclusion in the plan.