Debt Management Plan vs Debt Settlement - How Do You Decide Which is Right for You?
Debt Management Plans (DMP) and debt settlement are both ways to pay off debt, but they work differently. They also have different consequences, so it’s important to understand how they both work so that you can make the right decision for you.
Debt Management Plans
Payments are structured
In most cases, your interest rates will be lowered and certain fees (such as late or over limit fees) may be waived. You’ll make a monthly payment every single month to cover all of your included debts.
Debts are paid in full
Over the course of your DMP, your included credit accounts will be paid in full - usually in around 36 to 48 months.
You’ll save money
While you’ll pay off your debts in full, you’ll save money on reduced interest fees.
Your credit will likely improve
Assuming you make your make your required payment on time every month, it's very likely that your credit will have improved by the end of your program.
Read more: Credit Impact of a Debt Management Plan
Collection efforts should stop
If your accounts were delinquent prior to beginning a DMP, you may be receiving collection calls and letters. Once a creditor formally accepts the terms of a debt management plan, however, those calls and letters should stop. As an extra bonus, many creditors will actually re-age your account after a certain number of DMP payments - which essentially means they'll consider the account current even if you never made up those missed payments.
It’s not a given
Creditors don’t have to agree to the terms of a DMP, but chances are very good that they will. Remember - a DMP means you'll be paying your debt in full, which is preferable for creditors than having you file for bankruptcy or choose debt settlement.
You won’t be able to keep charging
During a DMP, your included credit accounts will be closed, meaning you won't be able to use those accounts for new charges. It's also recommended that you don't apply for new credit cards during a DMP, as creditors may choose to rescind your DMP benefits (reduced interest, waived fees, etc.) if they see that you're continuing to create new debt.
You might not be able to afford it
Debt management plans that are facilitated by nonprofit credit counseling agencies like MMI are required to be part of a sustainable budget. In other words, a credit counselor cannot suggest a DMP if the payments aren't affordable for you. While counselors strive hard to create a budget that supports your debt-repayment goals, it may be that your income is not enough to sustain your living expenses and a debt management plan.
You’ll likely pay less than what you owe
Settling your debt means you'll reach an agreement with creditors where they accept less than the full amont owed as the payoff amount. Settlement is the only repayment method where you pay less than what is owed, so you'll save money in the sense that you won't have to repay your full debt amount.
Your credit score will drop
Creditors generally will not negotiate a settlement on accounts that are current. This means most settlement programs will require you to intentionally miss payments in order to bring your accounts delinquent. These missed payments, plus the fact that accounts will be not be paid in full, will likely all have lasting negative effects on your credit score.
Read more: Credit Impact of Debt Settlement
Creditors may continue collection efforts
If you begin missing payments, you will very likely start getting phone calls and letters from various collection departments. The fact that you're attempting to settle your debt won't change this. They'll continue attempting to collect the debt until it's been paid or settled.
You may owe more in income taxes
Forgiven debt over a certain amount is usually viewed as taxable income by the IRS and will need to be accounted for on your income tax returns. Depending on the amount of forgiven debt, this could potentially cost you more in taxes.
It’s not a given
Creditors are not required to settle with you and can refuse. This could potentially leave you in a worse situation than where you started.
You will need to work with each creditor
Unless you use the services of a professional debt settlement company, you'll need to deal with each creditor individually.
Regardless of which one you choose, it would be in your best benefit to talk to a professional credit counselor to review your options. You may decide you don’t need their help, but most non-profit services offer a free consultation which can help you make the right decision for your situation.