Debt settlement and debt management both have a role in resolving debt problems, and it is important to know which is best for your circumstances. This guide analyzes debt management vs debt settlement, and helps you determine which is the best solution for you.
What is debt management?
Debt management involves negotiating lower interest rates and payments from your creditors to a more affordable level, and consolidating several payments into one.
Consumers often use credit counselors for debt management plans (DMPs). These companies contact your creditors and may negotiate more affordable terms on your behalf. DMPs consolidate your balances into one obligation for you, with a single monthly payment. They then distribute this payment among your creditors. Eventually, you repay all of your accounts.
Credit counseling companies offer more than just debt management. They can help you learn to create and stick to a budget, put away emergency savings, and save money for retirement. Debt management plans usually require you to close the accounts you’re paying off, so that you stay out of trouble and avoid running up additional charges.
Debt consolidation loans are an alternative to DMPs. Instead of negotiating lower payments from your creditors, you simply take out a personal loan and pay off these accounts. This gives you a single payment, ideally with a fixed interest rate that’s lower than what you’re currently paying.
It can be better than a DMP if:
- The new loan has a lower interest rate than the loans it pays off
- The new payment is more affordable
- You close out your paid-off accounts to avoid more debt
Debt consolidation lenders may or may not require you to close the accounts you pay off, but you probably should close some accounts to get and stay out of trouble.
Debt management is private
One consideration when looking at debt management vs debt settlement is the impact on your credit score. Legally, debt management is similar to a Chapter 13 bankruptcy filing, but it’s done outside the court system, and there is no public record. Your creditors often don’t report debt management on your credit history.
Often (but not always), there is no notation on your credit report that the creditor has made any concessions. And paying on-time into your DMP can show up as good, on-time payment history on your credit report.
Who can benefit from debt management?
Debt management can be an excellent strategy for those whose debt is not too extreme to be repaid in full. It can simplify your financial life by replacing many payments with just one. You may save on interest and penalties. You may sleep better at night. You can stop missing payments or paying late and improve your credit score.
A reputable, credit counseling agency can also educate you and help you learn valuable financial skills. You can repay your debts and move on to a more secure financial future.
Debt management considerations
Debt management, if you can stick with your plan, has very little downside. The key to successful debt management is to choose the right help. When you start a debt management plan, check with your creditors to make sure that your plan is paying them on-time. You don’t want a mistake to harm your credit rating.
Working with a member of the National Foundation for Credit Counseling should help you avoid high fees and access professional service.
The main reason that consumers fail a debt management plan is that they can’t ultimately afford it, or they complete it then run up more debt. You must change your habits to succeed with your plan.
What is debt settlement?
Debt settlement means getting your creditors to accept less than the total amount you owe as payment-in-full. It involves negotiating down the balance you owe to something you can afford.
Similar to a Chapter 7 bankruptcy, you can walk away from your balances by paying less than what you owe, and in exchange for a partial payment, your creditors forego the right to pursue the entire amount you owe.
Who can benefit from debt settlement?
While debt settlement can give you a “clean slate” like a Chapter 7 bankruptcy, it happens outside the court system, and there is no public record filed. This may make it easier for your credit score to recover, and it won’t stay on your credit report for ten years like a bankruptcy filing does.
If you can’t afford to repay your debts in full, debt settlement may be an appropriate solution.
How do you accomplish debt settlement?
You can try a do-it-yourself (DIY) debt settlement if you have a lump sum you can offer your creditors, and you’re comfortable negotiating on your own. For instance, if you have savings or can get a personal loan, take that amount, divide it by the total of what you owe your unsecured creditors, and send them a letter offering them an amount to release you from your debt.
There is no guarantee of success, but you may improve the chance of acceptance by offering at least half of what you owe.
For example, suppose that you owe $30,000 in credit card debt and collections, and the accounts look like this:
- Credit Card A: $10,000 balance
- Credit Card B: $7,000 balance
- Credit Card C: $9,000 balance
- Collection: $4,000
And assume that you can borrow $18,000. You’ll probably want to keep about $3,000 for taxes. The IRS requires you to pay taxes on any amount your creditors write off, and the exact amount depends on your tax bracket.
So assuming that you have $15,000 to pay your creditors, you could offer each one-half of what you owe to settle the account. It might look like this:
- Credit Card A: $5,000 proposed payment-in-full
- Credit Card B: $3,500 proposed payment-in-full
- Credit Card C: $4,500 proposed payment-in-full
- Collection: $2,000 proposed payment-in-full
If accepted, you could discharge $30,000 of debt for $18,000. But, if even one of your creditors declines your offer, you don’t have a clean slate. A debt settlement company’s experienced negotiators may have better success gaining an agreement among all your creditors.
If you have difficulty obtaining a loan for $18,000 and/or aren’t comfortable managing negotiations with all your creditors, you can seek assistance from a debt settlement company.
Using a debt settlement company
If you don’t have a lump sum, or aren’t able to negotiate the repayment deal, a debt settlement company may be able to get the result you need.
Debt settlement companies generally advise you to stop making payments to your creditors so that you can raise a lump sum. To make this strategy work, you deposit what you would have paid your creditors into an account with your settlement company.
When there is a large enough lump sum to make a settlement offer, the debt settlement company contacts your creditors. They work to settle the debt on your behalf and release you from additional obligation.
Debt settlement cautions
Be sure to understand debt settlement before attempting it. Unlike a Chapter 7 bankruptcy, your creditors are not obligated to accept your offer of partial payment.
If you withhold payments to save a lump sum, you can be subject to phone calls from collection departments. Your account may even be sent to a collection agency. Your creditors may choose to sue you rather than settle. If they win, they could garnish your paycheck.
Your credit score may be damaged with every missed payment. And your creditors might report that they settled for “less than the full amount,” which can diminish your FICO score.
Debt settlement fees can offset a portion of your savings. Compare providers and understand their fee structure and how much you might save.
Unlike amounts discharged in a Chapter 7 bankruptcy, balances written off by your creditors are taxable. You must plan for this bill or you may be in trouble again.
Debt management vs debt settlement depends on the amount of debt you have and your resources for paying it off. If you have too much debt to succeed with debt management, you may want to explore debt settlement.