All You Need to Know about Debt Management

If you’re struggling with mounting unsecured debt, debt management can help you keep up with your bills. Various strategies, such as the debt snowball method or working with a credit counseling organization, can assist you in creating a debt management plan that aligns with your budget and financial situation.

While credit cards make it easy to pay for large purchases or bills, managing debt and making timely payments can be challenging. As of 2023, most Americans have at least one credit card, with the average balance just over $6,500. Debt management offers a viable solution to help you regain control of debt that has spiraled out of hand.

Debt management helps you regain control of your finances through strategic planning and budgeting. The goal is to reduce and eventually eliminate your debt.

You can create a debt management plan on your own or seek assistance through credit counseling. Each approach has its pros and cons. Creating a plan yourself is straightforward and cost-effective, but working with a credit counseling organization can provide valuable negotiation support and accountability. Sometimes, having an external partner can make the process smoother and more effective.

Debt management plans focus on tackling unsecured debts, such as credit card balances and personal loans. Typically, debt management is carried out in one of three ways.


The first option is a DIY approach to debt management. In this version, you create a budget that allows you to pay off your debts while maintaining financial stability. The debt snowball and debt avalanche methods are popular DIY strategies.

Highlights

  • Who this is better for: If you struggle with overspending but can afford monthly debt payments by being more disciplined, this approach could work for you.
  • Biggest advantages: You can protect your credit rating by making timely payments in full. Additionally, you can create a realistic plan with milestones and a debt-payoff date to stay motivated.
  • Biggest disadvantages: You won’t have the insight of a professional who might have more effective strategies for faster debt elimination. Creditors may also be less open to negotiations.

You can use budget calculators, repayment calculators, and financial management apps to stay on track. If needed, you can try to negotiate with creditors to lower your monthly payments or interest rates. Once your debt is under control, you can decide whether to keep or close the account.

The second form of debt management is credit counseling. You can find a credit counselor through the National Foundation for Credit Counseling (NFCC). There are both nonprofit and for-profit credit counselors, so be sure to read reviews and understand any fees before signing up.

A credit counselor will help you devise a plan to repay your balances and can negotiate a debt management plan (DMP) with your creditors if necessary. These plans usually span three to five years and can include concessions like lower interest rates, reduced monthly payments, or fee waivers to help you get out of debt faster. Depending on your circumstances, creditors may close your accounts as each debt is paid off to prevent new debt accumulation.

Highlights

  • Who this is better for: People who want professional help managing their finances and credit score.
  • Biggest advantages: A DMP is generally more cost-efficient than paying creditors directly. You’ll get a set monthly payment and a debt-payoff timeline if negotiations are successful. Collection calls will stop, and the impact on your credit score won’t be as significant as settling balances for less than you owe.
  • Biggest disadvantages: You may not have access to your credit accounts during the DMP. You’ll also relinquish control of your debts to the counseling agency. Typically, you make a single monthly payment to the agency, which then distributes it to your creditors, possibly including a monthly fee.

Credit counseling can provide structured support and negotiations to ease your debt repayment journey.

Another option is to hire a debt relief company to help resolve your outstanding unsecured debts. These companies work by negotiating with creditors and lenders to reach settlement deals for less than what you owe.

When you sign up, you’ll make monthly payments to the debt relief company, which are held in an account only you can access. During this period, many debt relief companies advise halting payments to creditors and lenders to expedite the negotiation process.

Once a settlement is reached, it will be presented to you for approval. If you agree, funds from the account you’ve been paying into will be used to make the payment. The debt relief company will also collect a settlement fee from the same account.

Highlights

  • Who this is better for: Individuals overwhelmed by unsecured debt who have unsuccessfully tried settling on their own and prefer to avoid bankruptcy.
  • Biggest advantages: You could lower your monthly debt payments and potentially get out of debt faster, keeping more money in your pocket if settlement offers are successful.
  • Biggest disadvantages: Creditors and lenders aren’t obligated to accept settlement offers, which could lead to court action. Your credit score will likely suffer from settling debts for less than the full amount owed, and you might owe federal income tax if the forgiven amount exceeds $600.

Seek out a licensed nonprofit debt management company. While not all states require debt management service providers to be licensed, it’s beneficial to verify their credentials. Additionally, check if the firm is a member of a professional association, such as the Financial Counseling Association of America or the National Foundation of Credit Counselors.

For instance, Cambridge Credit Counseling claims to have reduced monthly credit card payments by an average of 25 percent. They also report negotiating average credit card interest rates from 22 percent down to 8 percent and highlight an average debt repayment period of 48 months.

Debt management can be an effective way to reduce debt, but it’s not an immediate solution. It does not cover secured debts like mortgages or car loans. However, it might be a good option if you:

  • Have multiple high-interest, unsecured debts like credit cards.
  • Are close to or at the maximum credit limit for each account.
  • Have a reliable income to make your payments.
  • Don’t anticipate needing to open a new credit account during your debt management plan (DMP).
  • Prefer having an agency or company negotiate your DMP instead of doing it yourself.
  • Have addressed risky financial habits, such as overspending.

While debt management can be a helpful tool to get debt under control, it can negatively affect your credit score.

A hard inquiry can occur at various stages of debt management. For instance, if you seek a lower interest rate, it may trigger a hard inquiry. These inquiries remain on your credit report for two years and can affect your credit score for one year.

However, this impact is short-term and can be offset by other factors. For example, securing a lower rate and consistently paying your monthly bill can positively influence your payment history, which constitutes 35 percent of your credit score.

While consistent payments will positively impact your payment history, missing payments will significantly lower your credit score. If you or your credit counselor employ a strategy of withholding payments from your creditors to negotiate a better rate, you should expect a decrease in your credit score.

Your credit utilization is a significant factor in determining your credit score, constituting 30 percent of it. It reflects the proportion of your debt to your available credit, with the ideal range being between 10 and 30 percent. This suggests that your total debt should not exceed 30 percent of the credit available across all your accounts.

While consolidating your debt into a single bill can streamline your payments, it may lead to an increase in your credit utilization ratio if you choose to close the accounts you’re consolidating. Debt management plans (DMPs) often necessitate the closure of credit card accounts as they’re paid off. Consequently, this action can impact your credit mix, which constitutes 10 percent of your credit score, and your credit history, accounting for 15 percent.

Consider your current financial situation carefully when deciding how to address your debt. While debt management is a viable option, it’s not the only one available. Explore alternative strategies to determine the best approach for your circumstances.

Consider utilizing balance transfer cards to consolidate your debt onto a card offering a 0 percent introductory APR. This enables you to focus on paying off your debt without accruing interest charges. Keep in mind that balance transfer cards often come with fees, typically applied per balance transfer. Additionally, initiating a balance transfer may result in a hard inquiry on your credit report unless you’re moving your balance to a preapproved card.

These cards are generally accessible to individuals with good-to-excellent credit scores. However, they may not be available if your credit score falls below a certain threshold. It’s crucial to have a clear repayment plan in place before the introductory APR period expires. Once the promotional period concludes, any remaining balance will be subject to the card’s regular variable APR.

Consider using a personal loan as a means of consolidating your debt into a single lump sum payment. Similar to a balance transfer credit card, this option offers a way to streamline your debt.

A personal loan might be suitable if you require more time to manage your debt effectively. Typically, these loans come with repayment periods ranging from two to seven years. Unlike credit cards, you must repay the loan in full by the end of the specified term, without the possibility of a promotional rate.

The interest rate for your debt consolidation loan will be determined by your credit score. Personal loan interest rates can vary widely, ranging from approximately 8 to 36 percent. Therefore, it’s essential to ensure that the rate you’re offered is lower than the rates you’re currently paying on your existing debt. Before applying, take the time to research the top personal loan options available to gauge what you may qualify for.

While bankruptcy should be considered a last resort, it offers a reliable means to eliminate a portion or all of your debt, or to establish a manageable payment plan with your creditors.

Under Chapter 7 bankruptcy, non-exempt assets are surrendered or sold, and the proceeds are used to repay unsecured debts. This option is preferable if you cannot feasibly manage a payment plan.

On the other hand, Chapter 13 bankruptcy involves adhering to a structured payment plan based on your income. Unlike negotiated plans, which may be rejected, creditors are obligated to collaborate with the court to facilitate your debt repayment. This process typically spans three to five years and is advisable if you possess sufficient income to repay a portion or the majority of your debts.

Managing debt can feel daunting, and finding the right solution to eliminate it can be even more daunting. Luckily, there are various debt management options available, such as the debt snowball, debt avalanche, debt management plans, and debt settlement, that can provide the relief you need.

However, these options vary in effectiveness and may have different long-term consequences. You might also consider alternative financing options like balance transfer credit cards or personal loans, which could be more appropriate for your situation. Take the time to carefully evaluate the pros and cons of each debt management method to make a well-informed decision that aligns with your financial goals and circumstances.