A debt management plan is a service offered by most credit counseling agencies. Through a debt management plan (DMP), you send the credit counseling agency a monthly payment, which the agency then distributes to your creditors. In return, you are supposed to get a break, usually in the form of creditor agreements to waive fees and to lower interest rates. The creditor will often agree to “re-age” the account as well. Re-aging is a way of starting over again with your credit cards after you have been behind for a few months. A DMP also allows you to make only one payment to the agency rather than having to deal with multiple creditors on your own. DMPs almost never involve a reduction in the total amount owed.
DMPs can be helpful for some consumers. For others, DMPs are a terrible idea. The problem is that many agencies will pressure you into a DMP whether it makes sense for you or not. A good agency will talk to you about whether a debt management plan is appropriate for you rather than assume that it is.
Beware of an agency that tells you that it has special connections with a particular creditor and can get you a better deal. Creditors generally offer the same types of terms through DMPs regardless of which agency they are dealing with.
A DMP may also have some effect on your credit report. Although some creditors disclose to credit reporting agencies whether a consumer is participating in a debt management plan, this won’t necessarily have a negative effect on your ability to get credit in the future. Fair, Isaac and Company, the developer of credit scoring software used by all major credit reporting agencies, has said that it does not negatively score a consumer’s participation in a debt management plan. On the other hand, individual creditors that pull your entire credit report may consider your participation as a negative factor if you apply for credit after you enter the plan. In any case, if you are considering credit counseling because you are behind in paying your debts, your credit score has likely already been negatively affected.
A DMP is often sold as a way of avoiding bankruptcy. This may turn out to be true if a DMP is right for you. However there are two very important to keep in mind if you think that a DMP will keep you out of bankruptcy court:
- Bankruptcy is not necessarily to be avoided at all cost. In many cases, bankruptcy may actually be the best choice for you.
- If you sing up for a DMP that you can’t afford, you may end up in bankruptcy anyway.
Below are a few questions to ask to help you figure out whether a DMP is right for you.
- Are you having trouble mainly with secured debts?
If you answered yes, a DMP is not likely to help you. There may be an exception to this general rule if you are only slightly behind on your secured debts. In that case, cutting your unsecured debts might free up extra money to help you pay your secured debts. Just remember that a DMP will not directly help you with your secured debt problems.
- Do you have little or no money left over in your budget each month to pay creditors?
If you answered yes, a debt management plan is not right for you.
- Are you still current on your credit cards?
If so, a DMP is probably not a good idea. You might be able to improve your situation by taking a budget counseling class and sticking to a tight budget, or by asking your creditors to reduce the interest rate on your cards.
- Are you able to pay your priority debts and still have some money left over each month?
If so, a DMP may be helpful. However, be sure to factor in any fees you will have to pay to the agency.
- Can you make a long-term commitment to making monthly payments?
If you answered no, a DMP will not help you. The drop-out rates for DMPs are very high, and it is a particularly bad idea to start out thinking that you probably can’t complete the plan. Ask the agency to explain to you how long it will take you to pay off your debts through a DMP. In some states, they are required to tell you this information.
- Do you want to keep using all of your credit cards while on a DMP?
If so, a DMP is not for you. Most agencies will require you to stop using any remaining credit cards. Some will allow you to keep one card for emergencies.
The bottom line is that a DMP is never a good idea if you do not have a significant amount of money left over each month to pay credit card debt.