How Does Debt Management Work?

Paying Off Debt, Personal Finance
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If you’re struggling to pay credit card bills every month but can’t seem to get any traction, a debt management plan might help. You make a single payment to a credit counseling agency, which then pays your creditors on your behalf.

A debt management plan won’t cut the amount you owe, but it might result in lower payments overall if a credit counselor can get your creditors to agree to a lower interest rate or to drop some fees — and that’s what usually happens. You also may be able stretch out payments. A debt management plan usually lasts from three to five years.

“Debt management plans can lower your interest rates and make your payments more affordable,” says NerdWallet columnist Liz Weston. “But many people still aren’t able to complete the plans. If you’re considering a debt management plan, you should also make an appointment with a bankruptcy attorney so you can understand all your options.”

Because you repay your original debt, debt management has much less effect on your credit score than debt settlement or bankruptcy, both of which land a knockout punch to your credit report.

» MORE: Compare debt management plans

How a debt management plan works

Expect a credit counselor to go over your financial situation thoroughly and to discuss several options, not just a debt management plan. Don’t feel pressured to sign up the same day a program is offered. Take time to think about it.

You’ll likely pay an enrollment fee as well as a monthly fee for each credit account in the plan. (Even with those, your overall monthly payment should be lower.)  The average monthly cost of counseling is $24, according to a 2014 survey of member agencies in the National Foundation for Credit Counseling.

Secured debts, such as those for houses and cars, are not covered. Student loans are not covered, either. Unsecured debts, such as credit cards and personal loans, are. The counselor will contact each creditor to notify it of the debt management plan and make itself the payer on your account. The counselor may seek concessions from each creditor, which can include lower interest rates, lower monthly payments or “re-aging” an account to stop late fees.

Each month, your payment will go electronically to the counseling agency, which pays your creditors. You get a progress report each month.

You should be prepared to live without credit cards for as long as you’re in the program. Most credit card issuers will require that the account be closed. You may be allowed to keep a card for emergencies or business, though; ask before you sign up.

You should be prepared to avoid any new credit obligations for the duration of the plan. Your creditors will see any new obligations on your credit report, and they may withdraw their concessions.

You should expect to make the payments on time, every time. Creditors have given you some major concessions, and they tend to insist on you meeting their terms. One missed payment and they may be done with waiving fees and charging less interest.

When debt management plans work best

If you’re struggling with revolving debt, the upsides are fairly obvious:

  • A single, lower payment.
  • No more (or at least fewer) phone calls from creditors or collectors.
  • The ability to finally put debt behind you.

It’s probably not right for you if:

  • You are having trouble paying secured debts, such as a mortgage or car payment.
  • Your income barely covers necessities, such as food and utilities.
  • You want to continue to use your credit cards.

Having to live without credit cards or new credit can be an advantage if a lack of self-control around spending has been a reason you couldn’t stay on top of debt.

Because you have to commit to many months of payments, you’ll want to make sure there is room in your budget to do so. Over the years you’re paying the plan, unexpected expenses will crop up, so access to some kind of emergency fund is crucial.

It’s even possible that financial coaching, by itself, is all you need to catch up. If you decide a debt management plan is right for you, it’s smart to get help with budget planning and money management to prevent you from falling behind again.

Is debt management the right option for you?

Debt management plans are offered by credit counseling agencies. If you’re thinking of going this route, look for a nonprofit agency that’s accredited by the National Foundation for Credit Counseling.

A debt management plan is only one option when debt seems overwhelming, and it might not be the right one for you.

Your credit score might initially drop, as accounts are closed and you have less available credit. Enrollment in a debt management plan will be noted on your credit report, but it is supposed to be treated as neutral in credit scoring. Long term, as you develop better financial discipline, your credit score is likely to climb.

Data is sparse, but what is available suggests at least half of clients do not successfully complete the plans. (Many do, however; do all you can to be one of those.) We suggest asking if your counseling agency will share that data with you.

Alternatives to a debt management plan include a debt consolidation loan, debt settlement and bankruptcy.

You may be able to do for yourself some of what credit counselors would do for you in a debt management plan. For example, you could pick up the phone and ask your credit card company about hardship programs; the worst they could do is say no.

Bev O’Shea is a staff writer at NerdWallet, a personal finance website. Email:boshea@nerdwallet.com. Twitter: @BeverlyOShea.


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