Debt management, debt consolidation and debt settlement offer different ways to obtain debt relief.
Debt can come swiftly or grow gradually over time. When bills begin rolling in and payments become overwhelming, there are options available to help. Before jumping into a plan, make sure you know your options for debt relief and which one best fits your situation.
While debt management, debt consolidation and debt settlement sound similar, each offers a distinct approach. The right choice can bring freedom and relief, while the wrong choice could harm your credit score and impact your finances for years to come.
The FCAA and its non-profit member agencies are here to help educate consumers about the best ways to manage and eliminate debt. This article explains the differences, pros and cons of debt management, debt consolidation and debt settlement.
Debt Management Plans
Debt management plans or DMPs combine multiple debts – like credit cards or personal loans – into a single monthly payment. Credit counseling agencies (CCAs) offer debt management programs to help qualified individuals overcome debt and learn ways to stay out of debt in the future.
“Debt management plans provide lower interest rates and affordable monthly payments, allowing consumers to fully repay their debts within five to six years,” said Phil Heinemann, Executive Director of Debt Management Credit Counseling Corporation (DMCC) and board member of the FCAA.
How does a debt management plan work?
A certified credit counselor will meet with you to learn about your unique financial situation. The counselor will then create a structured, individualized debt management plan with you and your creditors. This planning process will establish a monthly payment you can afford.
The monthly payment will go to the credit counseling agency, which will distribute it among the creditors. The non-profit credit counseling organization may charge a setup or enrollment fee and/or a monthly fee.
Debt management plans are a good fit when …
You have multiple unsecured debts. Debt management works best when people need to pay off multiple unsecured debts. This includes credit cards, personal loans, lines of credit and medical bills. DMPs typically are not used for car loans, mortgages or other secured debts.
You struggle to make payments and need help. When people struggle with monthly payments, fees and growing interest, debt management plans are a good fit. Often, people just need a little guidance and help to create a manageable plan to pay back their debt.
You want to avoid extra fees and collection calls. Debt management services can head off the impact of late payments and collections. Non-profit CCAs like FCAA members have relationships with many credit organizations. These creditors will stop all collections efforts and fees when you start a debt management plan, according to Heinemann of the FCAA.
You want to save money. The lower interest rates, waived fees and new financial plan will help you save money on your debt payments. Your new monthly payment in the debt management plan may be less than your current payment.
You want to build or strengthen your credit. A debt management plan may initially require you to close credit cards, which could make your credit score go down. However, the plan will help build or re-establish your credit as you pay down your debt over time.
You are willing to commit to the process. Debt management plans give structure and discipline to your financial life. Getting out of debt and learning healthy financial habits may feel uncomfortable at first. However, these habits will put you in excellent shape for the future.
Downsides of debt management plans
If you have secured debt or student loans, you generally cannot use a debt management plan. This includes a car payment and a mortgage.
You might need to close some of your credit accounts. You will have to follow the payment plan and may not be able to use those cards under the terms of the plan.
Your credit score may be impacted in the beginning. Closing some of the credit accounts while there is still a balance could change your credit score in the short term.
“Debt consolidation loans can be good if a consumer can pay off unsecured debts with an unsecured loan that has a lower interest rate and monthly payment,” said Heinemann. However, this requires creating a realistic budget and practicing self-discipline. Changing the way you live and spend money is tough without a plan or accountability.
How does debt consolidation work?
Debt consolidation moves debt from multiple sources into one payment source with a lower fee or interest rate, manageable terms and a reasonable monthly payment. You can consolidate debts on your own by opening a 0% balance transfer credit card and using it to pay off your other debts. You can also use the help of a lender to consolidate debts into a single payment. Banks, credit unions and online lenders offer such consolidation loans.
To qualify for these lower-interest options, people must have good or excellent credit. Furthermore, these loans may be secured or unsecured. Secured loans require collateral like your home, car, insurance policy or retirement account to back the loan.
Debt consolidation is a good fit when …
You have the financial ability and discipline to manage the payments yourself. With debt consolidation, you must diligently pay down debt with on-time payments. This approach may offer more flexibility than a debt management plan, but it requires strong financial discipline.
You can qualify for a debt consolidation loan. Most people consolidate debt with the assistance of a debt consolidation loan or low-interest credit card. You will have fewer accounts to manage and may be able to reduce your monthly payment. Lower interest rates may help you pay down debt faster and save money over time.
You have good or excellent credit. A high credit score is necessary to qualify for the lowest possible interest rates and make consolidation worthwhile.
Downsides of debt consolidation
Debt consolidation is not advantageous for people with severe debt problems. This includes those whose monthly debt payments exceed 50% of their gross monthly income.
A debt consolidation strategy may not save money based on the terms and conditions of the product you select. Read the fine print carefully before you sign anything.
You must create and stick to a budget that lowers your living expenses. This can be very challenging, and you may need to reach out to a financial counselor for help.
If you choose a 0% balance transfer credit card, you may fall back into debt with the new card if you are not careful. Some consumers tend to start using the credit cards they just paid off with the loan, landing them in more debt.
“In most cases, we do not recommend consolidating unsecured debts into secured loans like mortgages,” advised Heinemann. “When you borrow against the equity in your home or car, you take a great risk. You could lose your home or vehicle if you default on the loan.”
Debt settlement plans, sometimes in conjunction with debt relief loans, are installment payment plans that are used to pay off unsecured debts for amounts less than owed. They are typically a last resort for people with overwhelming debt.
How does debt settlement work?
“Debt settlement is the process of negotiating with your creditors to get them to accept less money than what you owe them,” said Heinemann. “You can do it yourself or hire a debt settlement company to negotiate with creditors on your behalf. But creditors will only agree to less money if they believe you are truly unable to repay the agreed-upon amount in full.”
You can try to settle debts on your own by contacting creditors and negotiating a lower payoff amount. If you do this, get everything in writing, especially the terms of your repayment.
Another option is to use a debt settlement company, which are typically for-profit entities that manage their clients’ debts. They collect monthly payments from their clients in lieu of paying creditors, causing your account to go delinquent.
After a significant amount of time, they negotiate a lower payoff amount with your creditors. In the process, the debt settlement company earns a percentage of the total debt.
Debt settlement is a good fit when …
You have substantial debt with one or more creditors. Debt settlement has the potential to wipe out a portion of the debt without having to pay the full credit card balance.
You want a DIY method to keep costs down. This approach has the potential to reduce your bills if you do it yourself. Debt settlement companies charge for their services.
Downsides of debt settlement
Months of high-pressure collection calls, major late fees and damaged credit scores are a few of the costs of the debt settlement process. When you stop paying bills, creditors will try to collect and may go to great lengths to recuperate their money.
Some creditors may not agree to a debt settlement. The late fees and impact on your credit score will continue if your creditors decline.
You will have to negotiate with your creditors if you choose not to use a debt settlement company. If you are not a talented negotiator, you may not reduce your debt enough to be worth it.
A debt settlement plan may also put you at risk of possible legal action.
“One of the most significant differences between debt management plans offered by non-profit credit counseling agencies and debt settlement plans offered by for-profit companies is that debt management plans are offered in conjunction with credit card companies while debt settlement plans are not,” said Heinemann. “With a debt management plan, credit card companies agree to cease all collection efforts and fees, whereas their collection efforts and fees will increase significantly with a debt settlement plan.”
Beware of dangers in the debt relief industry
Many predatory companies and scammers try to trick people who seek help with debt relief. To avoid scams:
- Make sure the company you work with is a member of the FCAA
- Work only with companies that provide full and transparent communication
- Avoid companies with pushy salespeople
- Be wary of unsolicited calls advising you to stop paying bills
- Be wary of any debt relief company that charges significant fees before services are provided, including those operating as part of an attorney network
When trying to pay off creditors, do not pay the pushiest creditors first. Look objectively at your debts with a certified credit counselor or on your own. Do research and make the best plan to pay off debt based on your situation.
Don’t lose your home, car or the security of your retirement by putting them on the line for unsecured credit card debt. Borrowing from your retirement account can also penalize you with an additional tax bill.
Understand the terms of any new agreements, loans or credit cards before you sign. Make sure you understand what you need to qualify, the fees, which creditors are being paid and how much, and any tax implications.
Carefully evaluate your options for debt relief
This article highlights the benefits and downsides of debt management versus debt consolidation versus debt settlement. Still, most people need help figuring out the best option for their situation.
The FCAA recommends reaching out to one of our non-profit credit counseling organizations to get free guidance. These counselors can review the options with you and help you set up a manageable budget.
You can also try out the FCAA’s free Debt Freedom Tool. This calculator helps you create a budget and then offers a debt relief recommendation specific to your financial situation. It will also provide contact information for a non-profit credit counseling agency licensed in your state.