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If you’re struggling to manage your debts, having trouble making payments on time or considering declaring bankruptcy, you may want to get professional financial help. Two options for debt relief available to consumers are debt settlement and debt management programs.
Depending on your financial situation, you may benefit from debt management, debt settlement or another form of debt relief, like debt consolidation. Both the debt management and debt settlement options have pros and cons. Before you commit to one path or another, make sure you understand how debt relief works and the difference between debt settlement and debt management plans.
Here’s more about what to expect from debt management plans and debt settlement and how each affects your personal finances.
Debt Management
Debt management programs, also called debt management plans or DMPs, are a service offered by consumer credit counseling agencies. Credit counseling agencies are nonprofit organizations that help people who are having trouble managing their debts but want to avoid declaring bankruptcy. Most of their services are provided at low or no cost to you as the customer. Credit counseling agencies are funded in part by creditors.
When you sign up to work with a credit counseling agency—along with your debt management program—you’ll receive personal finance coaching and advice on setting a budget, managing your money and credit more responsibly, and building a better financial future.
A debt management program gives you a fresh start and heightened focus on paying off your debt. The credit counseling agency will work with your creditors to negotiate a lower monthly payment to cover all of your debts, while waiving fees or reducing your interest rate if possible. In exchange, you agree to repay the full amount of your debt over a period of months or years. Most people on a debt management plan are able to pay off their debt within three to five years.
Why You Might Choose Debt Management
There are several good reasons to choose a debt management plan to help you get out of debt:
- One monthly payment. Credit counseling agencies help by giving you one monthly payment that combines all of your debts. You pay the agency this lump sum each month, and then the agency pays your creditors separately. Having just one monthly payment can help you simplify your finances, and the credit counseling agency is on your side in working with your creditors.
- Save money. Credit counseling agencies can work with your creditors to negotiate lower interest rates, get fees waived and otherwise help you save money on your debt payments. As a result, the new monthly payment you make as part of your debt management plan may be less than you were paying before. This can free up space in your budget to help you build emergency savings or work toward other financial goals while getting out of debt.
- No damage to your credit. Being on a debt management plan can help you build or reestablish your credit history. Your accounts get credited with 100% of the payments that you make over time. If you have some less-than-perfect credit history due to late payments or excessive debts, debt management can help you make a fresh start.
Alternatives to Debt Management
If your debts are at a manageable level and you do not want to commit to a multiyear debt management plan, or if you have good enough credit to qualify for another loan, you may want to consider debt consolidation instead. With debt consolidation, you may choose to combine your debts by repaying them all at once with a new loan, such as a personal loan from your bank or credit union, or by utilizing a 0% balance transfer credit card.
Debt consolidation can help you get out of debt faster by reducing your interest rate. But not everyone may be able to qualify for a lower-APR debt consolidation loan. If your credit is poor and you are having trouble making payments, you may need to consider what is seen by many as a last resort, debt settlement.
Debt Settlement
Debt settlement is a form of debt relief where people try to renegotiate the amount of debt they owe, and ask their creditors to accept a lower repayment. This can be done by the individual creditor or by using the services of a debt settlement company.
Instead of paying the total amount you owe (as you would with a debt management plan), debt settlement involves “settling” the debt for less than what you owe. Debt settlement can be risky and it can damage your credit. It should be considered only as a last resort for people with severe financial distress.
Why You Might Choose Debt Settlement
There are a few reasons to choose debt settlement:
- Cannot or don’t want to declare bankruptcy. If you are not able to declare bankruptcy, debt settlement may be an option of last resort.
- Cannot or don’t want to apply for a debt consolidation loan. If your credit is poor and you do not qualify for lower-interest debt consolidation loans or balance transfers, debt settlement may fit your needs.
- Willing to accept damaged credit. The debt settlement process will cause you to be delinquent on your payments and will damage your credit. If your credit is already poor, or if you are willing to take a hit on your credit as part of your longer-term plans to rebuild your finances, debt settlement may be a valid option.
Debt settlement is not the right fit for every situation because of the risks and credit damage involved. Still, in some circ*mstances, debt settlement may be worth pursuing.
Alternatives to Debt Settlement
Debt settlement will hurt your credit, so you may find a better solution to your financial problems by talking with a credit counseling agency and choosing a debt management plan.
Or, if you have adequate credit to qualify for a lower-interest loan or balance transfer, you may want to consider debt consolidation instead of debt settlement.
Debt Management vs. Debt Settlement: Which Is Better?
| Debt Management | Debt Settlement | |
|---|---|---|
| How It Works | With a debt management plan, a nonprofit consumer credit agency works with your creditors to arrange a combined lower monthly payment. You may also receive financial counseling and advice on how to set a budget. | You ask creditors to settle your debts for a lower payoff amount. Debt settlement can be done by yourself or by hiring a debt settlement company. Debt settlement companies negotiate with your creditors in exchange for a fee (a percentage of the total debt). |
| Does It Affect Your Credit Score? | Participating in a debt management program does not negatively affect your credit score. Successfully completing a debt management program may improve your credit—from your on-time payments and any reduction in your credit utilization ratio. | Debt settlement hurts your credit, because the process requires you to stop paying your bills and go delinquent on payments. This negative effect can stay on your credit report for seven years. This is one reason why debt settlement is typically considered a last resort. |
| What Does It Cost? | With an accredited credit counseling agency, most services are provided at low cost or no cost to you as the customer. Credit counseling agencies also can negotiate reduced interest rates and fees with creditors. | Debt settlement companies generally charge a fee of 15 to 25% of the total amount of enrolled debt. There is no fee if you negotiate with your creditors yourself. |
| Advantages | Debt management plans give you expert help and support. You receive financial counseling on how to improve your overall financial situation. The credit counseling agency develops a reasonable plan where you get out of debt and your creditors get paid in full. | Debt settlement can reduce the total amount of debt you owe. May be your best option if you are in serious financial difficulty and cannot make more payments, do not want to declare bankruptcy and do not want (or are not able) to apply for more loans. |
| Risks/Drawbacks | If your debts have reached an unpayable level and filing for bankruptcy is a better option, the credit counseling agency will talk with you about that and should be prepared to recommend bankruptcy instead. | Your credit will take a hit, you may have to pay income taxes on the forgiven debt and not all creditors will agree to negotiate or reduce your debt. Also, the FTC and Consumer Financial Protection Bureau have fielded complaints about unethical practices by some debt settlement companies. |
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Frequently Asked Questions (FAQs)
Can I negotiate a credit card debt settlement myself?
Yes, you can do DIY debt settlement, but it can be complicated, risky and damaging to your credit score. In addition, debt settlement requires you to go delinquent on your payments, which hurts your credit history and stays on your credit report for seven years. If you are having trouble paying your bills, you may want to start by talking to a nonprofit consumer credit counseling agency.
What percentage of a debt is typically accepted in a settlement?
Successful debt settlement typically results in your having to pay 50 to 80% of the original balance. But this is not guaranteed; creditors will not always agree to negotiate. Also, if you hire a debt settlement company, the company will charge a fee (generally 15% to 25% of your total enrolled debt) which you will have to pay out of your savings. (And debt that is forgiven becomes taxable income, with only a few exceptions.)
If you’re considering going through the debt settlement process and taking a hit on your credit, think carefully about whether the money you save on your debt is worth the cost and risk.
How do I negotiate with debt collectors for a lower settlement?
If you are already behind on your debt payments by 90 days or more, you may be able to negotiate a debt settlement. Talk to your creditor about your financial situation, explain why you fell behind on your bills and offer to settle the debt for some amount of money that you know you can pay, such as 50% of the original balance.
Some creditors will want a lump sum to pay off the settled amount, while others will accept a payment plan. If you have saved up some cash, you can negotiate with greater confidence.
