Understanding Debt Management Plans: A Comprehensive Guide

If you’re struggling to pay your monthly debts, a debt management plan (DMP) may help you make ends meet and eventually pay off your debt. A DMP is a repayment plan in which a credit counselor helps you determine how much you can pay toward your debt, consolidates your payments, and negotiates with creditors to possibly reduce interest rates and fees. You then make one monthly payment to the credit counselor, who pays your creditors until your accounts have no balance.

A whopping 70% of Americans report living paycheck to paycheck, according to a survey by research firm OnePoll on behalf of AmeriLife. If you find yourself in a similar situation, a DMP may provide a path to zero out your debt so you can focus on other financial goals such as buying a home or saving for retirement.

How Does Debt Management Work?

A debt management plan (DMP) is a repayment plan that helps you pay off your credit card and possibly unsecured personal loan debt. With a DMP, a credit counselor reviews your finances and informs you of your options. The counselor typically negotiates with creditors on your behalf to waive fees and lower your interest rates in exchange for repaying your debt through the DMP.

With lower interest rates, your reduced monthly payment could leave more room in your budget to repay your debt in full, which most DMPs aim to do within three to five years. Under a DMP plan, you’ll send a monthly payment to a credit counselor who distributes the funds to your creditors. Keep in mind, DMPs only cover unsecured debts like credit cards and some personal loans (though not student loans). They do not cover secured debts, such as mortgages and car loans.

To use a DMP, you’ll need to find a reputable credit counselor. The U.S. Justice Department provides a list of approved credit counselors by state; you can also look to the National Foundation for Credit Counseling for their list of accredited counselors. Some agencies charge an initial setup fee ($30 to $50) and a monthly maintenance fee ($20 to $75) for their service, but the money you save in interest could satisfy the cost with room to spare.

Pros and Cons of Debt Management Plans

Working with a credit counselor can provide insight into managing your debt and offer a number of advantages, such as:

Pros

• Reduced interest rates: Counselors can negotiate with creditors to secure lower interest rates, enabling you to pay off your debts faster.
• Single monthly payment: A DMP simplifies your monthly debt bills since you make a single payment each month instead of several.
• Avoid bankruptcy: DMPs provide an alternative to bankruptcy that helps you pay off debt without losing your assets or devastating your credit.
• Could help you improve credit: Making consistent, on-time payments can help improve your payment history and, consequently, your credit score over time.
• Create a budget: Your counselor works with you to develop a livable budget that makes room for debt payment and savings.

Cons

A debt repayment plan can help you pay off debt, but be aware of the potential drawbacks before enrolling in one.

• Closed credit cards: When you enroll in a DMP, you typically must close the credit cards that are part of the plan to avoid taking on more debt.
• No access to new credit: You usually can’t open new credit accounts while participating in a DMP.
• Includes fees: DMPs often charge a small enrollment fee and monthly maintenance fee for their service.
• Indirect effect on credit: Closing credit cards and other accounts can raise your credit utilization rate and lower your credit mix, which can negatively affect your credit, but not as severely as a default or bankruptcy.

How Does a Debt Management Plan Affect Your Credit?

Enrolling in a DMP doesn’t directly affect your credit score. However, your credit report will note you are participating in a DMP, which future potential creditors may consider when reviewing your application for new credit.

While your participation in a DMP won’t harm your credit score, the steps you must take under the plan could harm your credit scores in the following ways:

• Increased credit utilization: Closing your unsecured credit lowers the amount of credit available to you, consequently raising your credit utilization rate. That’s the amount of available credit you’re using, and it’s an important factor in your FICO® Score.
• Diminished account variety: Managing different types of credit accounts makes up 10% of your credit score, so closing accounts could shave points from your score.

On the other hand, DMPs can elevate your credit scores over the long term as you make regular, on-time payments. As your debt declines, your credit score should gradually improve over time.

Alternatives to Debt Management Plans

Even if a DMP is starting to sound like a good decision, weigh it against other alternatives to find the best option for your situation.

• DIY: You can perform many of the functions in your DMP yourself. For example, you can contact your creditors and try to negotiate a lower interest rate and fee waivers. Bear in mind that an experienced and certified credit counselor may be more likely to earn concessions from your creditors.
• Debt consolidation loan: A debt consolidation loan can pay off your existing debt accounts and combine the debt into one fixed-rate loan, ideally with a lower interest rate. The money you save could help accelerate the timetable to eliminate your debt.
• Balance transfer credit card: Another way to self-manage debt is to get a low or 0% introductory annual percentage rate (APR) balance transfer credit card. You typically need to have good credit scores to qualify, but the savings can be substantial.
• Debt repayment strategies: Debt repayment strategies, such as the debt avalanche and debt snowball methods, can help you eliminate debt by prioritizing your debts and creating a clear repayment plan. The debt avalanche method prioritizes paying off debts with the highest interest rates first to save money, while the debt snowball method focuses on paying off debts with the smallest balances first to create small wins and build momentum.
• Debt settlement: This strategy involves stopping payments to your creditors and attempting to negotiate with them to reduce or forgive your debt. As you might imagine, debt settlement is very risky, and it can have a severe negative impact on your credit.
• Bankruptcy: Bankruptcy is a last-choice option, but there may be no other options for some severely indebted people. A Chapter 7 bankruptcy will wipe out all allowable unsecured debts so you can start fresh, while a Chapter 13 bankruptcy lets you pay a wide variety of debts through the court over three to five years.

Should You Enroll in a Debt Management Plan?

If your credit is good and your debt is smaller, you may not need to enroll in a DMP. A strategic move like signing up for a balance transfer credit card with a 0% intro APR might provide you with the relief you need.

However, if managing excessive unsecured debt is overwhelming and it’s challenging to stay current on your bills, a DMP could help you alleviate the strain on your budget. Lowering your interest rates and monthly payments could help you avoid defaulting on a credit account or declaring bankruptcy.

If you choose to sign up for a DMP, your counselor will likely need a list of your current credit accounts. Consider checking your Experian credit report for free to review your open accounts and payment record. You can also monitor your credit throughout the process to see how your actions can impact your credit and see suggestions to improve your credit.

At O1ne Mortgage, we understand the importance of managing your finances effectively. If you’re looking to buy a home or need assistance with any mortgage services, don’t hesitate to call us at 213-732-3074. Our team of experts is here to help you navigate your financial journey and achieve your goals.