How can debt management help you manage your debt?

It's an all-too-common mistake to try to put off dealing with debts. Many people feel trapped in an endless cycle of debt repayment because they cannot afford to pay off large sums at once. Get your financial house in order by taking baby steps toward lessening your debt and a more secure future.

If you plan to get out of debt for good and are actively seeking solutions to help you do so, you're already ahead of the game. Keep in mind that there are two types of debt: good debt and bad debt. For example, a mortgage can get you one step closer to your dream of home ownership and, if the market values your property favorably, can even help you amass wealth; this is good debt.

However, taking on too much debt, especially in the form of expensive credit card debt, can make it challenging to achieve your other financial objectives; this, on the other hand, is called bad debt.

A debt management strategy is all about handling such bad, unsecured debts.

What is debt management?

Debt management is the process of managing debt through budgeting and rigorous financial planning. You can do it on your own or with the help of a third-party negotiator called a credit counselor. The credit counselor or organization communicates with your creditors on your behalf, aiming to reduce your interest rates and consolidate your debt into a manageable single monthly payment. This is called a debt management plan or program. These plans are designed to help you eliminate your debt over the course of three to five years.

How does debt management work?

There are two ways to manage your debt. The first way is to do it yourself, with the help of financial planning and budgeting. The other way is to do it with the assistance of a debt management program. Remember that you can only take care of unsecured debts like credit card debt through a debt management program.

Let's see how these work:

Do-it-yourself (DIY) debt management

In the first case, you can try your hand at debt management independently. Specifically, you make a budget and debt repayment plans, which help you get out of financial strain. The debt snowball and avalanche methods are effective as a do-it-yourself approach to debt relief. This is a great way to get out of credit card debt.

Tools like budget calculators, loan repayment calculators, and money management apps can help you stick to your financial goals. You can try to reduce your interest rates or monthly payments by negotiating with your creditors, if necessary. Once you've got your debt under control, you can decide whether or not to keep the account.

Pros and cons of DIY debt management

It's entirely up to you to figure out what fits your needs. Depending on spending patterns, financial responsibilities, credit history, and level of commitment, a DIY debt management plan for managing debt may work well for some people but not others.

Pros:

• A debt management plan simplifies your finances so that you can understand your spending habits which can be an eye-opener for you.
• If you can negotiate lower interest rates and no fees with your creditors, you will save a significant amount of money.
• Once you begin making monthly payments toward your debt, creditors and collection agencies stop contacting you.
• Your credit score will rise with a consistent fixed monthly payment plan and decreasing debt.
• Knowing that your debt is gradually dissipating will bring you a sense of relief.

Cons:

• Since you have chosen to go it alone, you will not be able to take advantage of the no-cost services a nonprofit credit counseling agency provides.
• Dealing with debt collectors, learning about available resources, and maintaining organization will require significant effort.
• You will need to figure out how to pay off your debt while meeting your basic living expenses.
• It will take you between three and five years to complete the process, so you must remain focused throughout that time.

What is a debt management program?

A debt management program provides a customized budget plan, reduces your interest rate, combines multiple credit card bills into a single monthly payment plan, and establishes a 3- to a 5-year payment plan. Credit counseling agencies, non-profit organizations, and some financial institutions typically provide debt management programs. Credit counselors can be found in both the nonprofit and for-profit sectors.

While signing up for a debt management program with a credit counseling agency, it's essential to read reviews and get a clear picture of whether they have a monthly fee that you might incur.

How do debt management programs work?

There are three steps to the debt management program:

Meet with your credit counselor

Credit counselors typically work with nonprofit organizations to offer debt management services (although there are a few for-profit organizations out there as well). They will negotiate with your creditors to reduce the rates and fees associated with your unsecured debt and assist you in developing a strategy to repay the debt.

Make a debt management plan

A credit counselor works with you to develop a strategy to manage debt so you can hopefully have it all paid off within three to five years and have a better financial situation. How? Once again, your credit counselors can reduce your overall financing costs by negotiating with your lenders to waive some or all of their fees. They can also help you get a reduced monthly fee.

The idea behind a DMP is to get back on track with your finances through a monthly DMP payment and pay off your debt faster by "saving" money on interest and other fees. You and your credit counselor will work together to create a debt management plan that perfectly fits your circumstances and the amount of negotiating room your credit counselor has.

Get rid of your debt

Having worked out a debt repayment strategy with a credit counselor, you should focus on eliminating your debt. Your credit counselor will handle the unpleasant task of making payments to your creditors on your behalf in exchange for their services. That's why it's presented to you as a single, convenient sum—along with the standard fees for setup and ongoing maintenance.

You should understand that working with a debt management plan isn't the magic solution you're hoping for. That's because it's not a magic solution. Why? Because it doesn't deal with the root cause of the issue, which is the tendency to use credit to cover monthly expenses rather than making and sticking to a budget. However, if you choose to tackle your debt, know that it will take time, effort, and patience.

What are the advantages and disadvantages of a debt management plan?

Types of debt you can resolve with a debt management plan

A debt management plan can be a foolproof way to get rid of debt, but it cannot resolve every type of debt. Only unsecured debt, debt that does not have any collateral, can be settled.

Debts like:

• Credit card debt
• Payday loan/cash advances debt
• Medical bills
• Personal loans
• Tax liabilities

How to find nonprofit credit counseling agencies for debt management plans

Debt management companies that are profit or non-profit and offer clear pricing have the best success rates. Furthermore, they typically have a proven track record of satisfied customers and the endorsement of an authoritative group like the National Foundation for Credit Counseling (NFCC).

The National Foundation for Credit Counseling (NFCC) maintains a database of legitimate nonprofit organizations. The NFCC has been providing free financial advice since its inception in 1951. Credit counseling agencies and debt management organizations must adhere to strict accreditation and membership requirements.

What to look for when shopping for non-profit debt management programs

When searching for a reputable nonprofit credit counseling agency, you should ask yourself the following questions:

Do they have any fees?

If you decide to use a debt management plan, whether it's for-profit or nonprofit, it's essential to understand the fees involved. That way, you'll know for sure if the set monthly payment is within your budget. Some debt management programs, as mentioned, may even be free or offer steep discounts, and clients pay to make the minimum payment towards their debt.

Understand the debt management plan they are offering

Find out how a credit counseling agency makes its debt management plans. You should learn if they provide settlement of debt options or debt consolidation services along with their plans or if they offer reduced interest rates. It is essential to know all the services they provide so that you can get the one that fits you best.

Check their track record

Ultimately, it's best to collaborate with credit counseling agencies that have a proven track record and are certified by the NFCC. You should make sure your counselor is an NFCC-certified credit counselor. You want to ensure that your monthly payments to the credit counseling agency are properly distributed to your creditors on time.

How do debt management plans affect your credit score?

Whether we like it or not, Americans love their credit scores. It's how financial institutions measure your "ability to handle" additional debt. Therefore, your credit score will change as you work to eliminate your debt and close your credit accounts through a debt management plan with or without a credit counseling organization.

Your FICO credit score comprises five factors: your payment history, amounts you owe, new credit, length of credit history, and credit mix.

A debt management plan will negatively or positively affect your credit score, depending on how well or poorly it is already established. Since payment history accounts for a sizable portion of your credit score, implementing a debt management plan could boost your score if you've been late in the past.

Let us see how it affects your credit score:

Hard inquiries

In the course of a debt management plan, a thorough investigation may become necessary. Seeking a better interest rate, for instance, could result in a hard inquiry being made on your credit report. Credit bureaus keep records of hard inquiries for two years when they may harm your score.

Nonetheless, this is only a temporary impact, and it is simple to counteract with other factors. For instance, if you can negotiate a lower interest rate that allows you to make regular payments on your bill, this will have a positive impact on your payment history, which accounts for 35% of your credit score.

Missed payments

Regular, consistent payments will help your payment history, but missing even one monthly payment will severely hurt your credit. Credit scores tend to drop if you or your counselor delay a monthly payment to creditors in hopes of negotiating a better interest rate.

Credit utilization

Credit utilization is a significant indicator of the overall health of your credit score. Credit utilization should ideally fall between 10 and 30 percent. Generally, you shouldn't use more than 30% of your total credit limit on debt payments.

As a result, your credit utilization ratio is calculated as the percentage of your available credit that you are actually using. Your score improves as your utilization rate decreases.

Consolidating your debts into a single payment can simplify your financial situation. However, this can affect your credit mix and history if you close some of your credit accounts. When you pay off the debt by closing credit card accounts or repaying loans, your utilization rate increases, and your credit score decreases. Thus, your total debt is lower, but you are using "more" of your available credit.

The principles of debt management

Here are a few principles that you should follow when trying to pay off your debt:

Understand your debt

Taking an honest inventory of your debts and making a list that includes them all can be the most challenging aspect of debt management. That list should consist of the following:

• Total amount(s) owed
• Rates of Interest
• Expected timelines and deadlines
• Any applicable termination dates. Some credit cards, for instance, may offer a low introductory APR for the first few months you use the card. If your rates are subject to increase, you should know when that might happen.

An essential step in this process is getting your credit report for free from the three major bureaus (Experian, Equifax, and TransUnion). This report can compile a complete accounting of your financial obligations.

A budget is essential for effective debt management

A budget is essential for a successful debt management plan. Once you have a firm grasp on your finances, you can formulate a workable spending plan. It may feel like you are denying yourself, but in reality, you prioritize your spending to secure a more comfortable financial future. By doing this, you'll make a wise financial decision to improve your financial situation.

Make only long-term purchases

Further advice for managing debt is only to charge large, long-lasting items like furniture or appliances. If you stick to your budget, you won't have to resort to charging small purchases like groceries on your credit card to get by until you get paid again.

Pay off the debts with high-interest rates first

Putting as much money as you can toward each bill is tempting, but focusing on the ones with the highest interest rates is the smarter move. As a result, you will save a significant amount of money over the course of your debt. You'll be making on-time payments toward reducing the debt's original principal rather than its accruing interest.

Ask for debt management help if needed

It's not a bad idea to contact your credit card company and ask if they can be flexible. Why not give them a call if you know you're going to be late on a payment that month? They could give you a later due date or extend the time you have to make the payment. Not everyone considers this a viable option for managing debt, but it can make a big difference.

It's also a good idea to inquire about getting your interest rate lowered. Don't treat your creditors like adversaries; instead, prove to be a responsible customer by making timely payments.

Other debt relief options if a debt management plan is not your fit

A few alternatives are available if a debt management plan does not help you take care of your debt.

Debt consolidation

Debt consolidation can be an excellent way to pay off your outstanding debt. With debt consolidation, you can combine your multiple debts into a single payment to help you pay your debt off quickly.

You can also use a debt consolidation loan to consolidate your multiple debts and pay them off. Like a debt management program, a debt consolidation program can be helpful. Credit counselors can combine your debts into a single payment by negotiating with your lenders.

Debt settlement

In debt settlement, you pay off your debt by paying a portion of your total outstanding debt. Here, you can negotiate a settlement agreement with your creditors on your own or opt for a settlement program where your credit counselors negotiate on your behalf.

Balance transfer card for credit card debt

A balance transfer is another debt relief option for debt management where you transfer all of your credit card debt to a single card called the balance transfer card and formulate a repayment plan to pay it off. Balance transfer cards usually have a low-interest introductory period where your debt incurs little to no interest.

During this period of reduced interest rates, you can easily make monthly payments to help you repay your debt and close your credit card accounts. But balance transfer cards usually charge fees every time a balance is transferred. If you plan to get a balance transfer card, make sure you have a good credit score.

Personal loans

You can combine your debts and save money with a personal loan that provides you with a lump sum payment all at once. A personal loan is a great alternative if you know you will need more time to control your debt. Most personal loans have a repayment term between two and seven years. In contrast to a credit card, your loan must be repaid by the end of the set time period.

A personal loan's interest rate is based on your credit score. Be sure that the rate you are offered is less than what you are currently paying on any other loans or credit cards you may have.

Frequently asked questions on debt management