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Debt Management vs. Debt Settlement: Which Is Right for You?
Paying off debt can be challenging, especially if your credit is in poor shape and your budget is tight. Debt settlement and debt management plans can provide some relief, but the two options—and their ramifications—are very different. Here’s how debt management and debt settlement work and what to consider before choosing either path.
What Is Debt Management?
A debt management plan (DMP) is a structured repayment plan administered by a credit counseling agency. It works similarly to debt consolidation by combining all of your unsecured debt payments—usually credit cards—into one. Once the DMP is established, you’ll make a single payment to the credit counseling agency, which will distribute the funds to your creditors. The agency may also negotiate lower interest rates and monthly payments with your creditors, and the repayment plan typically lasts three to five years.
Pros and Cons of Debt Management
Pros
- Doesn’t cause lasting credit damage: A DMP can help you improve your credit score over time by helping you stay on top of making on-time payments.
- Provides payment relief: With a reduced interest rate and lower monthly payment, you could save a lot of money and may have an easier time sticking to a repayment plan.
- Has a set repayment term: You’ll have a better idea of when you’ll be debt-free.
Cons
- Can damage your credit in the short term: Closing your credit card accounts can cause your credit utilization rate to spike.
- No new credit: You typically can’t open new credit accounts when you’re on a DMP.
- May not be cheap: Agencies charge an upfront fee to set up a DMP and ongoing monthly fees.
What Is Debt Settlement?
Debt settlement involves negotiating with a creditor to pay less than the full amount that you owe. You can settle a debt on your own or work with a debt settlement company or law firm. If you work with a company or law firm, they’ll typically encourage you to stop making debt payments while they negotiate terms with your creditors. Debt settlement typically requires a lump-sum payment instead of a restructured repayment plan.
Pros and Cons of Debt Settlement
Pros
- Can provide relief in a dire situation: Debt settlement could help you get out from under a significant financial burden.
- Helps you avoid bankruptcy: While debt settlement can do more damage to your credit history than a DMP, it won’t be as bad as bankruptcy.
- Can prevent other consequences: Settling with a debt collection agency can save you from a lawsuit, which could result in wage garnishment and other drastic measures.
Cons
- Can be costly: Debt settlement companies may charge between 15% and 25% of the total debt amount.
- Can devastate your credit: A debt settlement indicates that you didn’t pay as originally agreed, which can be devastating for your credit profile.
- No guarantee it’ll work: Creditors may refuse your attempt to settle.
Debt Management vs. Debt Settlement: Which Is Better?
Ultimately, the decision to get on a DMP or to settle for less than what you owe depends on your current situation, budget, and options. Here’s a quick recap of how the two processes differ:
| Feature | Debt Management Plan | Debt Settlement |
|---|---|---|
| Repayment | Provides a structured repayment plan over three to five years | Typically involves a lump-sum payment |
| Relief | A credit counseling agency can negotiate lower interest rates and monthly payments and combine multiple payments into one | Satisfies your debt for less than what you owe |
| Costs | Typically requires an initial setup fee of $30 to $50 and a monthly fee ranging from $20 to $75 | Debt settlement companies may charge 15% to 25% of the debt amount; creditors may tack on late fees and collection charges if you stop making payments; forgiven debt may be subject to income taxes |
| Credit score impact | Closing your credit cards can cause your utilization rate to spike, hurting your credit score until you pay off the debt | Missing payments during the negotiation process can damage your credit score, as can the settlement itself; these items remain on your credit reports for seven years from the original delinquency |
| Other risks | Creditors may cancel the DMP if you miss a payment or apply for other credit during the repayment period | Creditors may not be willing to negotiate with you |
| When to consider it | Your credit score needs some work, and you don’t qualify for or can’t afford debt consolidation | You’re already behind on payments, and neither debt consolidation nor a DMP is feasible |
Carefully Consider Your Situation to Determine How to Tackle Your Debt
Before you consider a debt management plan or debt settlement, take stock of your situation and research your debt repayment options. If you have great credit and room in your budget, for instance, a balance transfer credit card or debt consolidation loan may be worth considering. You can also look into accelerated repayment strategies.
On the other end of the spectrum, bankruptcy may be your only option if your financial situation doesn’t make anything else possible. Check your credit score before you proceed to better understand your options. If you’re overwhelmed, consider consulting with a credit counselor who can evaluate your situation and provide personalized advice, often free of charge.
For any mortgage service needs, contact O1ne Mortgage at 213-732-3074. Our team is here to help you navigate your financial journey with expert advice and personalized solutions.
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