Debt management programs can be a lifesaver for those deep in debt, but for others, they can do more damage than they do good. Debt management programs—also called credit counseling—is a booming industry these days, given how much consumers love their credit cards. As more and more people drown in debt, they turn to debt management plans as their solution. These plans are tempting to anybody struggling to stay afloat when it comes to their financial concerns. But what exactly is a debt management plan and how does it affect you? Does it affect your credit score? Is it legit? Will it help you or hurt you? These are some of the questions you should be asking. Read on to know more.
A debt management plan can affect you in several ways. As with any debt solution, there are pros and cons to it that you should consider before entering a debt management plan.
What is a debt management plan?
Debt management is a method to help you repay your unsecured debt like credit cards or personal loans. Think of it as consolidating your unsecured loans, making one single payment per month. A debt management plan is not a loan of any kind, unlike a consolidation loan. You make payments to your credit counseling agency, who in turn, make payments to your lenders each month.
A debt management plan is usually offered as a program through credit counseling agencies, to pay off unsecured debts like credit card debt and personal loans. Secured debts, like mortgages and car loans, do not qualify for debt management plans. Once you decide to get a debt management plan, a credit counseling agency will work with you to get information about your entire financial situation, including the amount of debt you owe. After gathering the information required, the credit counseling agency will work with your lenders to come up with a solution that works, like a repayment plan that is suitable for all the parties involved.
Once a plan is formed in accordance with your financial situation and the amount of debt you owe, you'll be responsible for making one monthly payment to your agency. The credit counseling agency will then distribute the money to each lender per the plan. The amount of time you'll take to pay off the debt you owe will vary with each plan. While on the debt management plan, it is extremely important that you make every payment on time, every time. Missing one payment or one late payment could mean higher interest rates and fees and in some cases, the lenders may opt-out of the debt management plan altogether.
Benefits of A Debt Management Plan
There are some crucial benefits when it comes to debt management plans. For starters, if you are in deep financial debt, most lenders offer a reduced interest rate so that repaying your debts becomes more manageable. Reduced interest rates can save you a significant amount of money over time. Also, in many cases, depending on your situation, late or over-limit fees may be reduced or waived. If you have a delinquent credit account, being on a debt management program can help stop collection agencies from contacting you.
Before going for a debt management plan, remember that every lender is different, and your benefits will largely vary depending on which credit accounts you want to be consolidated. Nearly all major lenders offer some sort of benefit for using a debt management plan though.
The payment you make each month will usually be less than the minimum amount you agreed to when you took the loan out, as is the case with most debt management plans. Once you’re on a debt management plan, most lenders will agree to stop interest and waive off associated charges as a gesture of goodwill—only if you’re willing to talk to them. However, this does not mean that all lenders will agree to waive off interest and other charges, as they’re not obligated to stop charging them. It never hurts to negotiate for the lowest interest rates though.
Debt Management Plan and Its Impact On Credit Score
When you are on a debt management plan, you usually aren't allowed to apply for any new line of credit during the length of your payment term. Additionally, being on a debt management plan will require you to close your credit card accounts so you can no longer make new purchases on them. Some plans do allow you to keep one credit card open for contingencies and other expenses, but not all plans allow them and require you to close all credit accounts.
This will take a toll on your credit score and cause it to plummet down—although, the effects are not permanent. The impact on your credit will differ depending on your specific situation and credit history. Your credit report will contain specifics that you are taking part in a debt management plan, but it should be removed after the payment period is completed. This note will not affect your credit score per se, but other actions will affect your score—like your payment behavior. Settling your accounts for less than the full amount owed can have a significant impact on your credit score as well. However, managing debt is more important if you want to maintain a healthy credit score.
The Downsides to Taking a Debt Management Plan
The most notable downside of taking part in a debt management plan is the negative impact it will have on your credit score. While repaying your debt more slowly is better than not paying it at all, a debt management plan will definitely impact your credit score negatively. Although enrollment in a debt management plan isn't a factor in credit scoring models, other aspects will factor in credit scoring models. Like, for instance, you will be asked to close all credit card accounts. Doing so affects your credit utilization ratio—closing accounts lowers your credit limit, which increases your credit utilization rate and hence negatively impacts your credit score. Closing accounts can affect account age as well. The length of time you've been using credit is also considered by credit bureaus.
Additionally, if you negotiate lower monthly payments or settle for less than the full amount owed, your credit report will reflect that the debt wasn't repaid as initially agreed upon. This can also harm your credit score. Although this note will be taken out after repayment of your debt, your credit score will likely remain impacted during the length of your debt management plan.
Finally, if you or the credit counseling agency fail to make payments on time, your credit score will naturally go for a toss.
Debt management plans are usually most beneficial to people who are in the deep end of debt and want to avoid bankruptcy. For some, a debt consolidation loan may be a better choice. Get professional and impartial advice before setting one up. A credit counseling agency can take a look at your financial situation and determine if a debt management plan is the best solution for you.