Debt management plan, consolidation or settlement: which is right for you?

Are you struggling to pay credit card bills and other debt and looking for relief? You might have seen bank ads shouting with urgency, “Consolidate your debt now!,” or debt settlement companies promising, “Leave your debts to us!” There is also a lesser-known alternative: a Debt Management Plan.

Learn what these options are to decide what is best for you.

Debt Management Plan

Debt Management Plans (DMPs) are offered through nonprofit credit counseling organizations, like LSS Financial Counseling, that are certified by the National Foundation for Credit Counseling (NFCC).

• Budget counseling is completed first to get an overall picture of your finances and see if the DMP is right for you.
• You will find out what your monthly payment will be, whether your interest rate will be lower based on creditor guidelines, and how much money a DMP will save you.
• Credit cards are closed once you are on the DMP, and creditors typically offer lower interest rates.
• By making on-time monthly payments, you will pay your debts in full in five years or less...and usually it is less. This will save you a lot in interest costs, compared to making minimum payments over a much longer period.
• Because your accounts are closed, your credit score may take a slight dip, but your score will subsequently increase with on-time DMP payments and the overall debt balance reduction.
• There are no credit minimum requirements. Taking out a consolidation loan (see below) is dependent on your credit history and credit report.
• Instead of making multiple payments to creditors, you make one simple monthly payment. (Please note: your debts remain with the individual creditors. The DMP is not a loan or a settlement. If you sign up for a DMP with LSS Financial Counseling, you make one monthly payment to us, and we disburse that money to your creditors each month.)
• There is a small, one-time set-up fee. The monthly fee is also very low and includes free, on-going support from experienced financial counselors to help you be successful in your journey to become debt free.

Debt Consolidation

Debt consolidation involves taking out a loan to pay off all your credit card debts/other unsecured debts. This might be a viable option for some people, especially if you have a good credit rating.

Before deciding on debt consolidation, ask yourself:

• Will the interest rate be lower than what you currently pay?
• Is the interest rate lower than what you can receive through a Debt Management Plan?
• Is the interest rate fixed, meaning it will remain the same for the life of the loan, or will it be variable?
• Will the new loan cover the debt balances in full, or is it a short-term solution, such as taking advantage of a temporary, promotional rate?
• Is the loan tied to collateral such as your home? If so, there are major risks. For example, if you miss loan payments tied to your home, such as a home equity line of credit, you could lose your house to foreclosure. The best option is a personal, unsecured loan that is not tied to any assets.
• Is the payment amount affordable?

Lastly, if you continue to use credit cards once the consolidation loan pays your balances in full, you will only add to your debt. Avoid charging unless you can pay off the credit card balance in full each month; be sure you have the cash on hand to cover any charges.  

Debt Settlement

Settlement usually occurs when you have not made debt payments for at least several months. The credit card company might continue to hold the debt, or it may be sold/transferred to a collection agency or attorney. At that point, the debt holder might allow you to pay your debt obligation for 20%-80% of the amount owed, but you must pay it in one lump sum.

When you don’t pay a debt in full, it will negatively affect your credit and credit score. Also, for any debt balance over $600 that was “forgiven,” you are required to claim the unpaid amount as income on your taxes, and you will likely be issued a 1099 form.

There are huge risks to not making your monthly debt payments. This increases the chance that creditors will issue judgments and garnishments against your savings, wages and/or tax refunds. Therefore, you should only consider debt settlement if you cannot afford to make your monthly debt payments.

Just Say No to Debt Settlement Companies

All of us can settle debts on our own – for free. NEVER PAY A COMPANY TO DO IT FOR YOU. Here’s why:

• The company will charge you large up-front and/or monthly fees.
• They typically do not offer financial counseling services to see if debt settlement is right for you.
• They might gloss over or avoid explaining the negative impacts of settling the debt.
• They often have highly marketable names that sound very patriotic or inaccurately imply legal expertise.
• If you have been making on-time payments to your creditors, the debt settlement company will tell you to stop. While you may believe it is because the settlement company is taking over your payments, this is NOT the case. The company tells you to stop paying so that they have a better chance of getting a settlement offer, which is not guaranteed. The result is your credit takes a major negative hit, because on-time payments are the most important factor affecting your credit score (35% of that score).
• Debt settlement companies have the same chance as you do in getting a creditor/collection agency to settle. Creditors do not have to offer this option. If the debt settlement company cannot get the creditor to agree to a settlement, you would be stuck with paying off the debt in full and all the company’s fees. Plus, your credit is now damaged because you have not been making on-time payments.

Regardless what you decide to do, it is okay to make only the minimum payment(s) due on your debt. Keeping up on those payments will help you avoid the negative effects of falling behind. During times of financial uncertainty, such as reduced income or a job loss, use savings to help you stay afloat. If you don’t have savings, once your income is back to normal, make savings a priority. Savings is the best way to help you avoid debt. 

LSS Financial Counseling is here to help during this stressful time. Our experienced financial counselors will work with you to create a realistic plan and budget to pay off debt and build savings. Call 1.888.577.2227 to schedule your free, confidential session, or get all your support online. Don’t wait – take action today!

Author Sarah Jannusch is a Certified Financial Counselor with LSS Financial Counseling.