There are many situations that may make it hard to pay off your credit card bills or loans, including illness, job loss, or simply missing a few too many credit card payments. And thanks to late fees and high annual percentage rates (APRs), it’s easy to fall into a debt hole.
Debt management plans or debt settlements may be able to help you get back on the right track. Although, the two are very different and affect your credit score in different ways. Depending on your situation, one method may be more successful in helping you take control of your financial wellbeing.
What is a Debt Management Plan?
A Debt Management Plan, or DMP, is a debt relief program that involves working with a financial coach to create a personalized budget. Your coach may work with you and your creditors by:
- Forming realistic monthly payment plans
- Minimizing your current fees
- Stop ongoing collection calls
- Teaching ways to pay off debt efficiently
When entering a DMP, multiple debts will be consolidated into a single, large debt. This is a good thing — it means you only need to make only one monthly payment. Each month your payments will be electronically collected and disbursed directly to your creditors on a fixed schedule.
Debt Management Plans – Pros and Cons
DMPs come with upsides and downsides, particularly when it comes to credit scores.
Debt Management Pros
Using a DMP does not directly affect your credit score. Some parts of the plan may improve your score over time, though others may have a temporary negative affect.
DMPs are designed to be paid off with regular monthly payments during a period of time that everyone agrees is reasonable. Ongoing, consistent payments will improve your credit score over time.
Starting a DMP requires you to close all of your current credit accounts. Creditors will see a notation on your credit report that indicates that you cannot have any new lines of credit. This will prevent you from taking out lines of credit that could continue to hard your report. Also keep in mind that once your DMP is complete, the notation is removed and does not have a negative effect on your score going forward.
Debt Management Cons
However, you should be aware that lenders and credit agencies like FICO use your credit history to generate a credit score. A temporary decrease in your available credit may have a negative effect on your score. And if you stop making your monthly payment on time, a dip in your credit score is possible.
Of course, these possible drawbacks are only temporary. Talk with our coaches to find out if using a DMP to bundle your debts into a more manageable payment plan is possible, and what effect it may have on your credit.
What is Debt Settlement?
This debt solution is ideal for those looking for a way to pay off their debts quickly. To work towards a debt settlement, you or a third-party settlement company must reach out to your creditors and negotiate a more ideal payment plan. You will then be responsible for paying a singular lump sum that will be less than the total amount you owe.
It should be noted that debt settlement does not work with:
- Federal student loans
- Mortgages
- Auto loans
Some debt settlement companies may require you to create a special savings account. The company uses this account to make settlement payments, so you can expect to have to deposit a significant amount initially.
Debt Settlement – Pros and Cons
Just like DMPs, there are both positives and negatives to debt settlement.
Debt Settlement Pros
Paying off a single lump sum will not only eliminate overwhelming amounts of debt, but it will also ensure that the creditor gets paid. If you’re close to declaring bankruptcy, debt settlement may be your best choice.
Debt Settlement Cons
Debt settlement does require some expertise and finesse to get right, though. Your creditors may not agree to negotiate a singular sum, or you may end up paying more than your original debt amount in fees. If you’re not careful, you may end up with even more debt than you started with.
That’s why it’s important to talk to an expert debt coach to make sure that settlement is the right choice for you.
How Debt Settlement Affects Your Credit Score
Unlike a DMP, debt settlements have a direct negative effect on your credit score. Although your debt will be paid off, it will be labeled in your credit history as “Settled.” Any notation in your credit history that is not labeled as “Paid in Full” may indicate that you are a high risk to creditors and can cause your score to drop anywhere between 45 to 160 points, based on your credit history.
Which Debt Solution is Right For You
The amount of debt you owe plays a role in which debt solution will help you the most. If you owe under $10,000 in unsecured debt, a DMP may be right for you. If you owe more than $10,000 in unsecured debt, debt settlement may be your best choice.
Another factor is the status of your debt. Debt settlement is typically only considered when you are severely delinquent in payments or already facing collections. Since there is no guarantee that a credit agency will accept a settlement, attempting to settle or withholding payment can backfire and bring on even more credit damage and debt.
On the other hand, a debt management plan is typically used when you are looking for a way to simplify multiple debts. You may turn to a DMP is you fail to qualify:
- Debt consolidation
- Balance transfers
- Personal Loans
Get Help Finding the Right Debt Solution
Handling unsecured debt can be overwhelming. If you’re still unsure about which way to go or want help managing your finances, reach out to our expert coaches today. Before you know it, you’ll be back on track to financial freedom.