According to the Federal Reserve Bank of New York, household debt now totals $16.90 trillion, $986 billion of which is on credit cards.
If your debts are causing you serious stress, you must take action. Debt settlement and Debt Management Plans are two of your leading options for dealing with unsecured debts like credit card debt, medical debt, personal loans, and private student loans.
Debt settlement can save you more.
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Table of Contents
Choosing the best option
Debt Management Plans and debt settlement use different approaches to pay off unsecured debts, but there are also a few key similarities.
- Debt Management Plans are typically run by nonprofit credit counseling services. You will make one payment a month to the credit counseling service. They will pay your creditors and negotiate better terms. You will repay your debts in full. You will also pay a monthly fee that ranges from $25 to $55, sometimes more.
- Debt settlement involves negotiating with creditors or debt collectors to accept less than the full payment amount you owe for a debt. You can negotiate on your own or hire a for-profit debt settlement company.
A debt management plan is better if you can pay your debts in full and want to protect your credit score. Consider debt settlement if you cannot afford to repay the total amount you owe and you’re looking for a financial reset.
At a glance: Debt settlement vs. debt management
|Debt settlement||Debt management|
|How it works||Involves negotiating with creditors or debt collectors to accept less than the total payment amount you owe for a debt||You will make one payment a month to a credit counseling service and will eventually repay your debts in full|
|Types of debt||Unsecured debts like credit card debt, medical debt, personal loans, and private student loans||Unsecured debts like credit card debt, medical debt, personal loans, and private student loans|
|DIY option||You can call your creditors yourself, so you do not have to hire a debt settlement company||You could contact your creditors, ask for a reduction in interest rates, and set up a payment plan|
|Primary benefit||Lower monthly payments||Simplified payments|
|Other benefits||You’ll pay off debts faster|
Greater long-term savings
Better option than bankruptcy
Settled debts are permanently resolved
Legitimate companies know which creditors and credit card companies refuse to settle
Any damage to your credit score won’t be lasting
Get out of debt within 12 to 48 months
Calls from debt collectors should stop
Working with professional negotiators
Familiar with state laws
|You can get out of debt within five to seven years|
You can resolve your debts without too much damage to your credit score
One monthly payment
Credit score doesn’t matter
Working with professional negotiators
|Primary disadvantage||Not all creditors or lenders will agree to settle||Completing a Debt Management Plan may take up to seven years and will cost more overall than debt settlement|
|Other disadvantages||Late fees could add up|
Does not include secured debts
Not all unsecured debts can be settled
The total amount of debt you have needs to be $10,000 or more
You can typically only include accounts that are $500 or more
Debt collectors can still attempt to collect the debt
|It may take up to seven years. It takes discipline and patience|
It will be a public record on your credit report
You may be required to close credit card accounts
Closing credit card accounts could cause short-term damage to your credit score
Most counseling agencies charge fees to administer a Debt Management Plan
Some creditors may refuse to join the plan
You could be dropped from the plan for missing or making late payments
If you drop the plan or if the plan drops you, any improvements in rates or fees negotiated under the plan will end
|Impact on credit score||There will be short-term damage at first but the long-term impact will be minimal||It may cause short-term damage to your credit score|
|Tax implications||The IRS may consider forgiven debt taxable income||None|
|Payment structure||You must make a lump sum or term payment after a settlement agreement is reached||You will make a single monthly payment to the credit counseling agency|
|Signs it may be right for you||You have more than $10,000 in debt|
You are facing financial hardship
You don’t have any money leftover each month after paying creditors
You’ve missed more than three consecutive monthly payments
|If you plan to take out a significant loan, like a mortgage or a car loan, in the near future|
- Both will require a steady monthly income.
- You will likely make one monthly payment with both debt relief plans.
- You can both consolidate or settle debt with a weak credit score.
- Professional negotiators will deal with your creditors on your behalf.
- Get creditors and debt collectors off your back.
- Both plans will take time and discipline to complete.
- If you enroll and do not complete either program, you could owe more fees than you started with.
READ MORE: Debt settlement fees
Both debt settlement and debt management enable you to achieve debt relief.
Debt Management Plan: A nonprofit credit counseling agency negotiates with your creditors to lower the interest rates on your debts, yet you’re still responsible for paying the total amount you owe, plus a monthly administration fee ranging from $25 to $55 per month.
Debt settlement program: A company negotiates with your creditors to lower the total amount you owe. With debt settlement, you will not pay back every penny of the total amount you owe. You will pay the company a percentage of the total debt settled, usually ranging from 15% to 27%.
Both options apply to unsecured debt (debt without collateral), such as credit card debt and personal loans.
READ MORE: When is debt settlement a good idea?
How debt management programs work
A Debt Management Plan (DMP) is a form of debt consolidation. Credit counseling agencies are typically nonprofit organizations. A credit counselor will set up the plan and negotiate with creditors for lower interest rates and better terms. You will no longer pay your creditors directly. Instead, you will make a single monthly payment to the credit counseling agency, simplifying your payments and making it less likely that you’ll forget one.
A Debt Management Plan typically takes three to seven years to complete, and you may have to close some credit card accounts. It is an effective way to get out of debt if you have the patience and discipline to complete the plan. This may harm your credit initially if you have to close credit card accounts, but the damage should be short-lived.
Always check the accreditation and the agency’s reputation. There are scams out there!
How debt settlement works
Debt settlement is negotiating with creditors or debt collectors to accept a lump-sum payment that is less than what you owe in full payment of a debt.
Creditors don’t want to accept a reduced amount, but it’s a better deal than bankruptcy (they get nothing) or selling your account to a collection agency for pennies on the dollar. If they think you can’t pay, they will often negotiate.
The debt settlement process has two major obstacles. You must make a lump sum or term payment to settle a debt. That means saving enough cash, which is hard for many borrowers to do. You will need to negotiate with creditors. Many debtors find this process intimidating and difficult.
You can save money for settlements and negotiate with creditors yourself or hire a debt settlement company to help you do it.
READ MORE: DIY debt settlement
Pro tip: A legitimate debt settlement company should offer a free initial consultation and demand no fees upfront. In addition, check with any company you’re considering to confirm that the company will provide access to an attorney if a legal problem arises.
The debt settlement industry is heavily regulated at the federal level, and some states also have strict laws limiting debt settlement companies. The Federal Trade Commission has provided a list of red flags if you’re looking for a legitimate debt settlement company.
READ MORE: Debt settlement companies
Which is the best option?
Both debt settlement and Debt Management Plans are legitimate options for people with serious debt problems. Your choice will depend on your personal circumstances.
A Debt Management Plan is a good option if you plan to take out a significant loan, like a mortgage or a car loan, in the near future. It may reduce your interest and fee expenses and should reduce your monthly payment, but it will not reduce the amount that you owe. It’s best for people with the capacity and the will to repay their debts over time. However, it ultimately could be more expensive than debt settlement.
Debt settlement is for people who cannot pay the full amount of their debts and are willing to take a significant short hit to their credit score and initially face escalated collection efforts to resolve their debts. It can be an effective way to reset your finances without filing for bankruptcy, and the overall cost will likely be lower than debt management programs. On average, debt settlement saves consumers $2.64 for every $1 in fees paid, according to the American Association for Debt Resolution.
Pro tip: The American Association for Debt Resolution was previously known as the American Fair Credit Council.
If your debts are completely out of control, your credit is already bad, and you’re considering bankruptcy, debt settlement is an option to consider.
Both take discipline and time
It’s important to understand that neither of these solutions provides instant relief.
A Debt Management Plan can take three to seven years to complete. If you work with a debt settlement company, it may take anywhere from one to four years to complete the program. Either way, you will need the discipline to make regular payments for several years.
READ MORE: Debt settlement pros and cons
Other debt relief options
If neither of these options seems right for you, other forms of debt relief exist.
- Debt consolidation with a personal loan or balance transfer credit card can simplify your payments and cut your interest costs. It’s a good option if you have good credit and can pay your debts.
READ MORE: How debt consolidation works
- Bankruptcy is an option if you can’t pay your debts. A simple Chapter 7 bankruptcy can discharge all unsecured debt in as little as six months. All debt collection efforts stop when you file, and most Chapter 7 bankruptcies do not involve the sale of debtor assets.
READ MORE: Debt settlement vs. debt consolidation
If you’re thinking about filing for bankruptcy, check out this video to learn what comes next:
Beware of individuals or companies offering debt relief “solutions” that sound too good to be true. There are many scams targeting people who are deeply in debt and desperate. Always research and check the credibility of anyone you’re considering working with.
READ MORE: Debt relief programs
The bottom line
Debt settlement programs and credit counseling organizations have a lot of key differences, but one thing is clear: Neither debt settlement nor debt management should be taken lightly and the company you choose to work with is a key factor in your long-term success. Consider the effects that both types of debt relief would have on your personal finances and your life before going with one of these options. Also, be sure to review the alternatives, such as a debt consolidation loan or a balance transfer credit card.
One option that is clearly wrong is doing nothing. If you are in financial trouble, you need to take action, and that starts with considering your options and choosing the best one for you. After all, your goal should be the most effective way to become permanently debt free and stay that way.
While the settled debts themselves won’t actually affect your credit score, there are a few other factors that will. Your score could take anywhere from six months to several years to recover. This will depend on how many late payments or charge-offs you racked up during the settlement process, your other credit accounts, your debt-to-income and credit utilization ratios and what your credit score was before you began the settlement process. You will need to manage your finances well to build better credit after debt settlement.
A Debt Management Plan may require you to close credit card accounts. This could affect the average length of your credit history and cause a small short-term drop in your credit score. If you make your payments on time, you should see rapid recovery and an improved credit score.
Yes, you can get a mortgage while enrolled in a Debt Management Plan. Some lenders may want to see a year’s worth of on-time payments, and your eligibility will depend on your credit score, debt-to-income ratio, and other factors. You also likely won’t qualify for the lowest interest rates. Discuss your plans with your credit counselor!