Is a debt management plan right for you?

A debt management plan is a program offered by not for profit credit counseling agencies to help individuals get out of debt. A debt management plan can be a great way for people struggling to get out of debt to manage their debt more effectively and potentially lower their monthly payments. However, it can have a long term effect on your credit, housing and employment options so do not take the decision to go on a debt management plan lightly.

How does it work?

These not-for-profit agencies create a debt management plan for you, otherwise known as a DMP and you make payments to the agency rather than to your creditors. The agency renegotiates lower interest rates and gets many of the fees waived. They handle all of your payments for you, and you just make one payment to the counseling agency every month. They tend to charge a small fee for their services, but it is usually quite fair.

These debt management plans tend to be structured out over three to five years. The reason for this is that the agency needs to show the creditors that you have hit hard times and are struggling to make ends meet and pay your debts, and if you pay too much in the beginning it is hard to paint this picture. In most cases, people are already struggling to make payments on time and this is not an issue.

During the three to five-year period that you are on the DMP, creditors will suspend all of your lines of credit. You will not be able to make any purchases on credit, even in emergency situations. You will not be able to apply for a credit card, loan or any other type of financing. You must also keep in mind that it will be notated on your credit report that you are participating in a DMP, which can be a cause for concern for landlords and employers.

How does a DMP affect your credit?

The answer to this question really depends on your situation. The main points to keep in mind here are that creditors do not want to see a) defaults, b) AP’s or Arrangements to Pay, or c) late payments.

If you can avoid defaulting on a debt before and during the course of your DMP, you may be surprised to see the positive long term effects that the DMP can have on your credit. On the other hand, defaulting can make it really hard to receive credit in the future, and makes you a very risky borrower.

Arrangements to Pay are viewed negatively by creditors as well, because it essentially means that you are not paying your debt in full but rather negotiating to settle for a lesser amount. This is significantly better than defaulting, but is still a red flag to prospective creditors.

Late payments are also bad for your credit report, but not nearly as much so as defaults or AP’s. Try to make all of your payments on time every month so that your credit score does not go down further. Many creditors will give you a short grace period of 15-30 days to get your payment in without marking you late, but you should not rely on this as it is not a law or requirement for them to do so.

If you plan and follow your DMP strategically and responsibly, it can actually have a positive effect on your credit over time. Your balances will be going down faster, and your debt to income ratio will be improving. You will have marks on your report for having been under a DMP, but over time this will become less and less important to future creditors.

Creditors tend to look at the most recent two to three years, because they understand that life changes frequently. You could be making more money now, or managing your expenses better and therefore are able to keep your debt under control.

However, if you default on debts and make late payments during the course of your DMP, this could have an incredibly negative effect on your credit going forward. You may find it hard to get approved for any type of credit, loan or financing for several years after finishing the DMP. You may have to start rebuilding your credit as if you are a new borrower, by getting a secured credit card and slowly building up your credit profile over time.

Getting a mortgage during a DMP

You may find it incredibly difficult to get approved for a mortgage during a debt management plan. There are a few reasons for this:

• A DMP is a red flag and means that you have trouble paying your debts
• Making payments to your DMP is an outflow of cash every month, which hurts your affordability position with a mortgage lender
• Your credit may be in a bad state during a DMP

A great alternative to a DMP

There is one excellent alternative to a DMP – doing it yourself! A credit counseling agency is not doing anything that you cannot do for yourself. All they are doing is contacting your creditors and renegotiating terms for you. If you take the time to research your options and learn how to approach your creditors, you may be able to renegotiate your debts quite effectively on your own.

Here are two reasons that you might want to run your own DMP:

1. You are in control of the whole process. Anything that you are not comfortable with – you can decide not to do.
2. You don’t have to pay any management fees when managing your own DMP.

Here are two reasons you may not want to run your own DMP:

1. You do not have the time, patience or motivation to do so. Be honest with yourself. Are you going to be responsible and take the time to follow your DMP to the letter? If not, you may be better allowing a credit counseling agency manage your DMP for you.
2. You are not tough enough to have difficult conversations with creditors. If you know that you can be easily bullied by creditors, you may prefer to have someone manage your DMP for you.

In conclusion

A debt management plan can be an excellent option for you to consider if you have debt and you are finding it difficult to manage. You can either work with a credit counseling agency or manage your own DMP, but either way you may see a great long term benefit from a DMP. There are some important factors to consider before diving in, but whatever you do you should be commended for making the decision to focus on handling your debt responsibly.