What is a debt management plan and how does it work?
A debt management plan (DMP) can help you manage overwhelming bills and take control of your debt. If your debt is getting out of hand, a DMP may be a good option.
5 min read
It’s not uncommon to have some form of financial obligation—whether it be credit card debt, a personal loan, or a mortgage. Indeed, debt need not be such a bad thing. A manageable amount of debt can help you take control of your finances or free up some income for necessary expenses. But debt can also get out of hand and lead to negative consequences, and that’s where a debt management plan may be something to consider.
In this article, we’ll review the basics of debt management plans and look at a few ways to successfully manage a large amount of debt.
What is a debt management plan?
A debt management plan—sometimes referred to as a debt management program, or a DMP—is a strategic effort to manage overwhelming bills and take control of debt. A solid debt management plan can reduce the number of payments you’re required to make each month and allow you to ultimately eliminate some (or all) of your high-interest debts.
The goal of a debt management program is to gradually lower your debt so you can get back on track to achieving financial balance.
How do debt management plans work?
Under a typical debt management plan, multiple unsecured debts—credit cards, personal loans, etc.—are rolled into one monthly payment.
If you work with a debt management company, that company may negotiate with creditors on your behalf to develop a manageable payment plan. This plan may involve lowering your monthly payments, reducing your interest rates, or waiving certain penalties. In exchange, you may have to agree on a structured payment schedule that typically takes a few years to complete.
There are two primary ways to lower your debt obligation with a debt management plan:
Do-it-yourself debt management
You can get your debt under control by creating a plan to pay off your debts yourself.
While this may sound like an overwhelming task, it doesn’t have to be. You can use financial management apps as well as budgeting tools such as N26 Spaces to organize and plan your various expenses. If necessary, you can also try to negotiate with creditors yourself to see if they’ll reduce your monthly payments or interest rates.
Taking the DIY route can be a straightforward way to eliminate your debt if you’re disciplined and resourceful.
Debt management with the help of credit counselors
While setting up a debt management program yourself can be the least expensive way forward, sometimes it can be helpful to seek professional advice. Many people find it easier and less stressful to work with debt management companies or credit counselors to create a sound debt management plan.
As mentioned earlier, debt management companies can negotiate with creditors on your behalf to decrease your debt obligation. Just as importantly, these professionals can help you identify the root cause of your debt and develop a program based on your income and spending habits.
The pros and cons of debt management plans
A good debt management plan can have numerous advantages, including:
- Reduced interest rates that enable you to pay off your debt faster.
- Consolidated payments that can help to simplify your finances.
- The peace of mind that comes with having a plan.
However, debt management plans can also have their drawbacks:
- Typically, you can’t use a DMP to negotiate the settlement or forgiveness of secured debts such as auto loans, mortgages, or tax obligations.
- DMPs typically take several years to complete, and you may be unable to use your existing credit cards or qualify for new lines of credit during that time. This means you must have enough income to cover your existing expenses while sticking to your payment schedule.
Who should consider debt management?
A debt management plan can certainly be an effective strategy for managing debt. But it isn’t always the best solution for every financial problem out there.
A DMP is not a quick fix—since these programs are set up for three to five years, repaying the debt may take a long time. And a DMP may require you to close your credit card accounts, or advise against using credit cards not included in your plan except in case of emergency.
With that said, enrolling in a debt management program may be a right fit for you if:
- You have high-interest debt and a steady income.
- You think you’ll be able to settle your debt within three to five years with a lower interest rate.
- You can get by in the next several years without a credit card or new line of credit.
Alternatives to debt management plans
As you explore ways to eliminate your debt, the best strategy is to choose a solution that works best for your income and spending habits. Take some time to evaluate your expenses and your future income before settling on a path forward.
Here are a few other debt-repayment options that may be worth considering:
The 50/30/20 rule is a straightforward budgeting method that allows you to divide your monthly income into three categories: 50% for needs (rent, mortgage, electricity, transportation), 30% for wants (dining out, shopping, entertainment subscriptions), and 20% for savings or paying off debt.
Keeping your expenses balanced across these areas helps you manage your money simply and effectively. If your debt is less than 15% of your annual income, using the debt avalanche or debt snowball method may help you pay off debt more efficiently.
Debt avalanche method
In the debt avalanche method, you concentrate on paying off your highest-interest debt first, then the one with the next highest interest, and so on. This strategy saves you the most in interest charges but requires discipline in sticking to the payment plan.
Debt snowball method
The debt snowball method involves paying off debts from smallest to largest, regardless of the interest rate. This strategy enables you to completely eliminate some debts in a shorter time, giving you quicker results and motivating you to keep going.
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