Debt relief and debt repair come in many shapes, including debt management and debt settlement. Debt management usually comes with a debt management plan (DMP) that lasts for up to 5 years: during this time, you are expected to repay your debt on more favorable terms. Debt settlement aims at settling your debt whereby you repay only part of your debt.
Some people find debt management the right solution for their debt issues. Others find that they don’t have enough financial space to carry with a debt management plan and need to settle a debt instead.
The choice between debt settlement and debt management depends on your personal financial situation and your financial expectations for the future. This post explains how each debt relief solution works and which one best fits your needs and your personal finances.
Here are the pros and cons of debt settlement vs debt management.
Debt Management
Debt management is a structured repayment plan designed to help individuals pay off their unsecured debts, such as credit card balances and consumer credit loans. Debt management plans are provided through the assistance of a credit counseling agency.
How It Works
Credit Counseling: The process begins with a credit counseling session, where a certified counselor reviews your financial situation, including income, expenses, and debts. They help you create a budget and discuss possible debt solutions. The aim is to help you repay your debt in a manageable way that matches your income and living expenses.
Debt Management Plan (DMP): If deemed appropriate, the counselor will help you enroll in a Debt Management Plan. This consolidates your unsecured debts into one monthly payment made to the credit counseling agency.
Negotiating Terms: The agency negotiates with your creditors to secure lower interest rates, waive fees, and potentially reduce your monthly payments. These negotiations can make your debt more manageable and help you pay it off faster.
Regular Payments: You make a single monthly payment to the credit counseling agency, which then distributes the funds to your creditors according to the agreed-upon plan. Once you have repaid your debt in full, you are debt-free.
Debt Settlement
Debt settlement negotiates with creditors to accept a payment that is less than the full amount owed to settle your debts. When your debt has reached unmanageable levels but you don’t want to file for bankruptcy, debt settlement might be the right solution for your financial dead end.
How It Works
Hire a Debt Settlement Company: You work with a debt settlement company that negotiates with your creditors on your behalf to reduce the principal amount of debt that you owe. Creditors agree to accept less than full payment to settle. You deposit money into a dedicated savings account during the debt settlement program and payment to creditors is made through this dedicated account.
Accumulate Funds
As you deposit funds into the dedicated savings account, the settlement company negotiates with your creditors to accept a reduced payment. If creditors see there is no hope for them to recoup the total debt you owe them, they are likely to accept a reduced payment rather than risk losing the full sum.
Settlement Agreements
Once sufficient funds are available, the settlement company reaches an agreement with your creditors and pays them the negotiated amount from your dedicated savings account.
Debt Resolution
Once your debt has been settled, you are debt-free.
When to Consider Debt Management
Persistent High-Interest Debt
If you're dealing with high-interest credit card debt that you can't seem to reduce despite making regular payments, a debt management plan can come in handy.
Through a DMP, a credit counseling agency can negotiate lower interest rates with your creditors to make repayment easier and help you pay down the principal balance faster.
Multiple Debt Accounts
Managing multiple debt accounts can be overwhelming. If you have various credit card balances, personal loans, or other unsecured debts, a DMP can consolidate them into a single monthly payment to simplify your financial life.
This single payment structure can help you stay on top of your monthly payments and reduce the risk of late payments.
Difficulty in Budgeting
If you find it challenging to create and stick to a budget, working with a credit counseling agency can provide the structure you need. These agencies offer financial education and personalized budgeting assistance. The fact that you have an external plan that you have to stick to can add discipline to your financial planning.
Minimum Payments Not Making a Dent
Minimum payments on credit cards only go toward interest, not the principal. This can trap you in a cycle of debt that feels impossible to escape. A DMP can lower your interest rates and help you pay off debt more quickly as you pay off the principal and not just interest.
Maintaining Credit Score
If you need to maintain your credit score — for example, you plan on buying a home or a car — a DMP might be a better option than alternatives like debt settlement or bankruptcy to pay off credit. Enrolling in a DPM is noted on your credit report but it doesn't have the same negative impact as missed payments, settlements, or bankruptcies. Over time, a DMP can even improve your credit score, as long as you keep to it.
Financial Stability but Overwhelmed by Debt
If you have a steady income but feel overwhelmed by the amount of debt you carry, a DMP can provide a structured path to debt reduction. You'll make a single, predictable payment each month, which can ease financial stress and help you regain control over your finances.
Avoiding More Drastic Measures
A DMP is a proactive approach that can help you avoid more drastic measures like filing for bankruptcy, which can have severe and long-lasting effects on your financial health and credit score. A DMP offers a structured, responsible way to manage your debt without resorting to such extreme measures.
When to Consider Debt Settlement
Significant Financial Hardship
If you're experiencing severe financial hardship due to job loss, medical expenses, or other unexpected life events, and you're unable to keep up with your debt payments, then debt settlement could be a practical option.
In such cases, you should negotiate with creditors to settle for less than the full debt, as it’s unrealistic of them to expect you to repay the full amount of your debt.
High Debt-to-Income Ratio
When your debt-to-income ratio (DTI) is excessively high, a substantial portion of your income goes toward paying off debt. This can make it challenging to make any sort of progress with your finances.
If your debt is unmanageable and you're barely covering the minimum payments, then debt settlement can help reduce the total amount you owe.
Default or Near-Default Status
Creditors may be more willing to negotiate a settlement if they believe it's their best chance to recover some of the owed money.
If you're already in default on several accounts, or on the verge of defaulting, debt settlement can offer a way to avoid more severe consequences like lawsuits or wage garnishments.
Lack of Assets
For individuals who do not have significant assets to protect, such as a home or retirement savings, debt settlement can be a more attractive option compared to bankruptcy.
Bankruptcy, especially filing for Chapter 7, can lead to the liquidation of assets. Debt settlement focuses on negotiating the debt down to a more manageable level without necessarily involving asset liquidation.
Inability to Qualify for Debt Management Plans
If you've explored debt management plans (DMPs) but find that your financial situation does not qualify you, or the payments are still unaffordable, then debt settlement might offer an alternative.
DMPs typically require that you commit to a regular payment plan and you have to repay your debt in full. Debt settlement, however, can provide a more immediate reduction in debt obligations.
Willingness to Accept Credit Score Impact
Debt settlement will likely hurt your credit score, as many people find it necessary to stop making payments to creditors during the negotiation process. If you're willing to accept this trade-off for the potential to significantly reduce your debt, then debt settlement might be a good option for you.
This impact on your credit score can last a few years, affecting your ability to obtain new credit. On the other hand, you may already have a bad credit score, in which case settling your debt is more important.
Facing Imminent Legal Action
If your creditors are threatening or have initiated legal action to collect debts, settling the debt may prevent judgments and further legal complications. Settlement can halt the escalation of debt collection actions and could provide a resolution that avoids court proceedings.
No Better Alternatives
When other debt-relief options, such as DMPs, consolidation loans, or personal loans, are not viable, debt settlement becomes a more compelling option.
If your financial analysis and possibly professional advice point toward settlement as the most feasible path to debt relief, it might be the best choice.
Debt management vs. debt settlement at a glance
|
|
Debt management |
Debt settlement |
|
Amount paid |
The full debt you owe. You may be able to waive late fees and lower the overall interest rate on your debt. |
Typically around 50% of your overall debt, as creditors often allow for an amount of forgiven debt. |
|
Credit score impact |
Not a direct impact on your credit score; DMP is noted on your record. |
Affects your credit score; the drop depends on the level of debt, financial situation, and other criteria. Stays on your credit history for 7 years. |
|
Missing a payment |
You have to pay every month. Missing a payment may cancel your DMP. |
You might stop making payments while you negotiate a settlement. You make deposits into a dedicated savings account throughout the program. |
|
Timeline |
Three to five years |
Usually two to four years. |
|
Fees and costs |
Initial fee of up to $100. |
Fees are only collected after a settlement has been reached and payment made to the creditor. The debt settlement company will take a portion of the amount you owe on your debt as its fee. |
|
Advantages |
You can be debt-free within a few years and retain your credit score intact. |
You don’t repay the full debt amount. Up to 50% is settled and you save money in the long term. |
|
Disadvantages |
You have to pay the full amount you owe. You must keep financial discipline. |
It stays on your credit record for 7 years. For a few years, you may not qualify for a loan or a mortgage. |
Alternatives for Debt Relief
Debt Consolidation
Debt consolidation rolls multiple debts into a single loan with a lower interest rate. This simplifies payments and can reduce the overall interest paid over time. You still repay the full amount you owe, so consolidation may not help you save money. Debt consolidation works best if you have a relatively good credit score so you can benefit from a lower interest rate. Debt consolidation is often used as a credit card debt relief option, as credit cards usually have high interest rates and fees, and consolidation loans may come with lower rates.
Credit Counseling
Credit counseling agencies offer professional advice on managing debt, creating budgets, and improving your money management and financial literacy.
Debt Snowball Method
Focus on paying off the smallest debt first while making minimum payments on others. Once the smallest debt is paid off, move to the next smallest, and so on.
Debt Avalanche Method
Focus on paying off debt with the highest interest rate first while making minimum payments on others. Once the highest-interest debt is paid off, move to the next highest, and so on.
Bankruptcy
Bankruptcy is a legal process that can provide relief from debts, but it has significant long-term consequences. You have to file for bankruptcy and risk losing part of your assets during the process, as creditors will try to recover as much as possible of the debt owned. Your credit score will take years to improve.
Loan Modifications
For secured debts like mortgages and car loans, loan modifications can adjust the terms of your loan to make payments more manageable and better fitting with your current financial situation.
Contact ClearOne
If you are struggling financially and don’t know which solution is best for you, then contact a ClearOne Certified Debt Specialist today at 866-481-1597. We’ll explain your options based on your personal circumstances and get a free savings estimate to see how much each can save you!
