How a Debt Management Plan Affects Your Credit Score

Written by Banks Editorial Team
4 min. read
Written by Banks Editorial Team
4 min. read

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Debt management plans are a form of relief for financially distressed consumers. Keep reading to see how they work and the impact they could have on your credit score. 

What Is a Debt-Management Plan or Program?

Non-profit credit counseling agencies offer debt management plans (DMPs). They provide relief to overwhelmed debtors who struggle to repay their credit card and personal loan balances. 

Under the plan, you will make a single monthly payment instead of multiple payments to each creditor. You will also get a drastically reduced interest rate to help you pay down debts faster. 

The ultimate goal of a debt management plan or program is to help consumers pay their credit card debts in three to five years. 

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How Does a Debt-Management Plan or Program Typically Work?

Debt-management plans are only available to consumers with credit cards, personal loans, and other unsecured debts. Unfortunately, secured debts like auto loans and mortgages aren’t eligible for inclusion in a debt management program. 

When you enroll in a program, your assigned debt counselor will reach out to your creditors to negotiate the terms of each account. For example, they may ask the creditor to waive late fees and bring the account current or decrease the minimum monthly payment and interest rate. But there’s a catch – most credit card issuers will require you to close your account to participate in the program. 

Instead of making the minimum payment to your creditors for debts under the DMP, you will pay the credit counseling agency. In turn, they will remit payment to your creditors and send you a monthly report to keep you up to date with the repayment progress. 

Expect to pay an enrollment fee to participate in the program. In addition, a monthly administrative fee may also apply for each enrolled account. 

The Benefits of a Debt-Management Plan

There are several benefits to signing up for a DMP, including: 

  • Financial counseling from a debt-management professional: This service is generally available free of charge before you enter into the DMP. You will review your budget and current debts with a credit counselor to create a realistic action plan.
  • Cost savings: You will save money if your credit counselor can negotiate a reduced interest rate.
  • Simplicity: You can make one payment each month to the credit counseling agency instead of several payments to creditors 
  • Financial relief: You can pay off your debt within three to five years, and the debt collectors should stop calling within a few months.
  • Higher credit score: See possible improvement from late marks when all accounts are brought current (although your score may initially drop when you close your accounts) 

If you decide to move forward with a DMP, only consider non-profit agencies accredited by the National Foundation for Credit Counseling. Ask around for recommendations and read consumer reviews from past and current clients before enrolling. 

Is a Debt-Management Plan Right for You? 

A DMP is ideal for consumers who are overwhelmed by unsecured debts and desperately need relief. You should also have enough income to make your monthly payments under the plan. 

However, this approach may not be suitable if you’re barely making ends meet and will have trouble making the required monthly payments under the plan. You may also want to rethink a DMP if you want to keep your credit cards open. 

The good news is there are other ways to manage your debt if this option isn’t a good fit. 

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Ways to Manage Your Debt

Consider these strategies to manage your debt effectively. 

Self Debt Management

It’s possible to devise a debt-payoff plan without professional help. You’ll need to commit to meeting your goal and being persistent throughout the process. Here’s how to get started: 

  • Step 1: Know where you stand. Write down your creditor’s name and contact information, current balance, credit limit, minimum payment, due date, APR, and status (current or past due). 
  • Step 2: Rework your budget. This allows you to free up funds and allocate them towards debt. 
  • Step 3: Create a debt-payoff fund. These funds will cover any extra you pay on debts beyond the required minimum monthly payment. 
  • Step 4: Select a debt-payoff strategy. Popular strategies are the debt snowball and debt avalanche. 
  • Step 5: Execute. Be consistent each month, and you will reach your goals. 

Debt Management Plans 

As mentioned earlier, DMPs are best if you’re having trouble keeping up with your credit card and personal loan payments. There could be negative implications for your credit, and you may have to close your credit card accounts. However, successful execution of the program could help you get out of debt in three to five years. 

Debt Settlement Programs 

For-profit entities offer debt settlement programs that allow you to pay less than what you owe on your debts. You can get out of debt faster by paying less than you owe under a settlement agreement, but your credit rating will take a hit when you stop making monthly payments to your creditors.

Credit Counseling 

Credit counseling is generally available free of charge by non-profit organizations. Sessions help consumers create a spending plan and responsibly manage their debts. Be sure to research your options before registering for a session, as some entities charge a fee for a readily available service free of charge. 

Debt Consolidation 

Personal loans and balance transfer credit cards help you pay down balances faster and possibly save on interest. But you should have good or excellent credit to qualify for debt consolidation products with competitive interest rates. 

Bankruptcy 

You can file for bankruptcy as a last resort to get relief from your debts. However, your credit health could take a hit as bankruptcies remain on your credit report for up to ten years. 

How a Debt Management Plan Affects Your Credit

Here’s a closer look at how a debt management plan impacts your credit score: 

  • Past-due accounts can be brought current to stop adverse credit reporting. 
  • Timely monthly payments could help improve your payment history. And you will pay the balance in full, which is far better for your credit health than a settled account. 
  • Your credit utilization will increase when you close credit cards, which can temporarily ding your credit score.

The Freedom Debt Relief Program 

If a debt management program, credit counseling, or bankruptcy don’t quite work for you, debt settlement is worth considering. You may also have questions if enrolling in a debt settlement program can impact your credit score. According to a Freedom Debt Relief 4-year study based on clients that completed their program and the help of the top three credit bureaus, credit scores initially dropped for the first six months after enrolling in the program, but after that period, the client’s credit scores started to recover. They also concluded that clients who completed the debt relief program developed better financial habits and reduced their debt burden, resulting in long-term credit score recovery.

Reaching out to a reputable debt settlement company, like Freedom Debt Relief, can help you reduce your debt burden by negotiating with creditors on your behalf to reach a fair settlement, which can lead to a higher credit score long-term and a better financial future.

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