Almost as soon as credit cards became commonplace in the United States, organizations arose to help cardholders deal with their debts. In 1951, the National Credit Counseling Foundation opened to the public. Another national trade association, the American Financial Advisory Association, opened in 1993. Through these nonprofits, people can get free financial advice and, in some cases, enroll in a debt management plan.
Debt Management Plans (DMPs) are designed to help people with urgent credit card debt remove costly and unmanageable balances. Here’s what you need to know about how they work.
What is a debt management plan?
DMP is a consolidation program. Instead of paying your creditors directly, you must make one payment to a credit counseling agency, which then distributes the payments to your creditors for you. This is not a loan for consolidation or debt settlement, but an agreement with a third party.
Generally, the creditors you must include in a DMP are credit card companies, although some also allow you to include other debts such as medical bills, unsecured loans, and collection accounts.
Your credit cards may be current or expired, but in any case, you will close the accounts and will no longer be able to withdraw money from them. The intention is to get out of debt as quickly as possible. In most cases, the plans are designed to pay off the debt in full within three to five years.
Debt management plan fees and interest
In addition to not having to manage multiple lenders, making your financial management easier, most credit card companies have pre-set agreements to reduce or even eliminate interest for people who participate in the plan.
“Every lender has a different policy,” says Howard Dworkin, Debt.com chairman and founder of Consolidated Credit Counseling. “Some waive interest entirely, some cut rates, and others charge interest in full and then pay it back to you when you’re done with the plan. Ninety-nine percent of lenders help in one way or another.”
Depending on the credit counseling agency, there may be a one-time setup fee, which typically ranges from $30 to $50, as well as a monthly administration fee of $20 to $75. However, under certain circumstances, many agencies waive these fees.
How much can you save with a debt management plan?
With DMP, the payment you make remains constant. After paying off each debt, the remaining creditors receive a larger payment.
Lowering interest rates and maintaining a fixed payment schedule can have a big impact on the amount of money and time you save, especially when initial annual interest rates and balances are high.
For example, credit advisory agency Money Management International recently demonstrated the difference between paying off $18,150 credit card debt while adhering to the credit card company’s minimum payments compared to using DMP:
- Minimum payment: At an average annual rate of 27.77%, it will take 351 months to pay and $40,573 in interest. The total payment will be $58,723.
- DMP: With an average annual interest rate of 6.41 percent, it will take 48 months to repay and $2,445 in interest. The total payment will be $21,828.
In this scenario, DMP will save you $36,895 and 25 years of payments.
This is an agreement, not a contract.
Registration with the DMP is completely voluntary. You do not contract with an agency and they offer some flexibility. You can send more money if you have extra funds to help you pay off your debt faster. And if you want to go into self-management, just let the credit counseling agency know. At this point, you can start making payments yourself again. Just be prepared to pay and raise rates.
“Once the credit counseling agency notifies your creditors that you are no longer in the plan, payments and interest revert to what they were before,” says Dworkin.
Although you agree to make the entire payment as agreed by a certain day of the month (usually electronically withdrawn from your checking account), it is important to contact the agency if you have any problems. If you fail to meet the payments you make through DMP, interest rates will most likely return to what they were before. The agency can step in and help you find a way to pay on time or stop credit card companies from taking these actions.
How do you know if you qualify for a debt management plan?
Your first step is to book a free appointment with a credit counseling agency, which you can find by visiting either the National Credit Counseling Foundation or the American Financial Counseling Association. You will meet with a loan counselor, usually by phone or online. These professionals have been specially trained and certified to provide budget and debt advice.
A loan consultant will review your income, expenses and debts. The appointment usually takes an hour. After that, the consultant will give recommendations to help you make ends meet, or suggest various resources.
DMP payments are based on individual lender requirements. Some expect 2 percent of the balance, others 2.5 percent, others 3 percent.
In case you have too much money left in your budget, DMP won’t make sense because you can clearly manage your own financial affairs with a few adjustments. If you don’t have enough money to pay for DMP, it won’t be presented because it won’t help your situation. In this case, your advisor may suggest coping plans or even consider filing for bankruptcy.
How Debt Management Plans Affect Credit
Unlike debt settlement or filing for bankruptcy, with DMP you will pay off 100 percent of your debt. For this reason, credit card companies tend to favor these plans. You not only return the amount you borrowed, but also restore a positive relationship with them.
If you started a DMP as past due, after three consecutive payments, most credit card companies will mark you as current on your credit report. This won’t clear up past due payments (they’ll stay for a total of seven years), but it can help you rehabilitate your credit. Payment history is an important factor in your credit score, so getting back on track with DMP can have a positive impact on your scores.
Another benefit of a loan is that it can free up funds to pay for other financial obligations. The total amount of DMP you pay can cut your initial payments by up to 30 percent, Dvorkin says. This money can then go towards paying a mortgage, car payment, student loan, or any other debt that you cannot include in the DMP.
However, there are some issues to be aware of. You will close your accounts, which can increase your credit usage – the second most important factor in the FICO score. However, when you pay off your debt, your use of credit will end up in a better position.
Some credit card companies do report that you are working with a third party to pay off your balances, but this note is not included in the FICO score. If other lenders or companies extract your actual credit report, they will see it and be able to form their own opinion about whether it is negative or positive.
bottom line
“DMP is just one tool, but under certain circumstances it can be really useful,” says Dworkin. If it saves you a significant amount, gets you out of debt quickly, and repairs bad credit, DMP may be a wise decision. It can also offer much-needed relief after trying to shuffle bills and getting phone calls from creditors wanting to know why you didn’t make a payment.
A credit counseling plan can also be your opportunity to develop healthy financial habits. A consultant will help you create a budget that will reduce waste. When you pay off your debt, you won’t rely on loan products to bail you out when you run out of cash. By the time you make your last DMP payment, you should be in a much better position to grab the best credit cards and not drown in exorbitant balances.
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