Debt settlement programs and debt management plans (DMPs) help consumers break the chains of debt bondage. They aren’t quite the same, though, and each has different implications for your credit and overall financial health.
In this guide, you’ll learn how they work, along with the benefits and drawbacks of each option. You’ll also discover how to evaluate and select the best fit for you.
Debt Settlement vs. Debt Management Programs: Key Differences
Below is an overview of how debt settlement programs and DMPs work.
Debt Settlement Programs
They’re generally offered by for-profit entities and aim to settle your debt for a fraction of what you owe. Instead of paying creditors each month, you will deposit funds into a dedicated account used to pay creditors who agree to settlement offers.
Only unsecured debts are eligible for debt settlement programs. These include credit card debt, personal loan debt, payday loan debt, and medical debt.
Debt Settlement Process
Here’s how the debt settlement process works:
- You meet with a Certified Debt Specialist to discuss your debt goals. In turn, they review your financial situation and create a plan of action.
- You enroll in the debt settlement program and begin making the agreed-upon monthly payments to a dedicated account.
- When the dedicated savings account reaches a certain amount, the debt settlement firm begins negotiating with creditors on your behalf.
- Each time a settlement is reached, you review the terms of the agreement. If you agree, funds from the dedicated account are used to pay the settlement amount.
- You can continue to make monthly payments into the dedicated account until every debt enrolled in the program goes through the negotiation process.
Debt Settlement Program Advantages
There are many potential advantages of enrolling in a debt settlement program.
- Lower your balances: You could reduce your outstanding balances by a sizable amount and free up funds to meet other debt goals.
- Save a bundle in interest: Only paying a reduced amount of what you owe means you’ll also save hundreds or thousands in interest.
- No up-front fees: You’ll only pay when a debt is settled.
- Pay off debt faster: Eliminate your debt in as few as 24 to 48 months.
Debt Settlement Program Disadvantages
Unfortunately, there are also drawbacks to consider:
- No guarantees: The creditor could reject settlement offers.
- Adverse credit reporting: If you choose to forgo paying creditors to accelerate the debt settlement process, late payments will likely appear on your credit report and hurt your score. Each time you settle and the creditor notates the account as “settled” instead of “paid in full”, your credit score could also take a hit.
- Steep fees: Expect to pay between 15 to 25 percent of the settlement amount of each account.
- Tax consequences: You could be liable for taxes on the forgiven amount if it exceeds $600
Debt Management Plans
DMPs are offered by non-profit credit counseling agencies and are sometimes available free of charge. Unlike debt settlement, DMPs are designed to help you repay the total outstanding balances on your debts by negotiating concessions with creditors.
Typical concessions include reduced monthly payments, interest rates, or fee waivers.
Debt Management Process
Here’s how the debt management process works:
- The credit counselor meets with you to review your finances and explain your options. If there’s a good fit, you enroll in a DMP.
- You make monthly deposits to the credit counseling agency.
- The credit counselor reaches out to your creditors to become payers on your accounts and notify them of your enrollment in a DMP. Most credit counselors will also negotiate concessions on your behalf.
- The credit counselor uses your deposits to pay creditors each month.
- You continue to make monthly deposits to the credit counseling agency until your debts are paid in full.
Debt Management Program Advantages
The perks associated with DMPs include:
- Streamlined repayment process: You’ll only make one monthly deposit instead of several monthly payments to creditors.
- Fewer collection calls: Creditors will cease collection activity once your accounts are current and they begin receiving consistent monthly payments again.
- Faster debt-payoff: DMP plans are effective if you uphold your end of the bargain and make the required monthly deposits.
Debt Management Program Disadvantages
Some drawbacks to consider:
- Card closures: Many credit card companies will close your cards while enrolled in a DMP. This could hurt your credit score if your credit utilization, or the amount of your credit card limit in use, increases.
- Monthly fees: The credit counseling agency could assess a sign-up and monthly fee for each account enrolled in the program.
Debt Management vs. Debt Settlement: Which is Better?
Torn between debt management and debt settlement? Here’s how to decide which is more suitable for your financial situation.
When is a Debt Settlement Program the Best Debt Relief Option?
If you’re struggling to stay afloat financially and can’t afford to repay your unsecured debts, debt settlement is worth considering. While there are serious consequences for your credit health, you can possibly pay less than what you owe, save a ton in interest and get back on track financially once you complete the program.
When is a Debt Management Plan the Best Debt Relief Option?
DMPs may be ideal if you can afford to make the minimum payments on your unsecured debt and want accountability on your debt-payoff journey. A credit counselor can also educate you on ways to more effectively manage your finances.
