Debt management plans (DMPs) have become an increasingly popular option for consumers struggling with unmanageable debt burdens. If you’re facing piles of debt and looking for solutions, understanding how DMPs work is crucial.
In this comprehensive guide, we’ll explain everything you need to know about debt management plans, including:
- What is a DMP and how does it work?
- The pros and cons of a debt management plan
- What are the requirements and eligibility?
- How to enroll in a DMP with a credit counseling agency
- The effect on your credit score and report
- What happens if you don’t pay your DMP?
- Alternatives like debt consolidation loans and bankruptcy
- And more
Gaining a full understanding of DMPs will allow you to determine if this debt relief strategy is right for your situation. Let’s start by examining what debt management plans are and how they function.
What is a Debt Management Plan (DMP)?
A debt management plan, sometimes referred to as a debt consolidation plan or credit counseling plan, is an agreement between a consumer and a credit counseling agency to repay unsecured debts under new negotiated terms.
The credit counseling agency works on the consumer’s behalf to get creditors to agree to reduced interest rates, waived fees, and a consolidated monthly payment. This allows the consumer to repay their debts in full over an extended repayment term, typically 3-5 years.
The key features of debt management plans include:
- One consolidated monthly payment to the credit counseling agency
- Negotiated reductions in interest rates
- Lower monthly payments spread over longer repayment terms
- Creditors waive late fees and over-limit fees
- Creditors often agree to freeze interest accrual
- Full repayment of enrollment debts over the DMP term
The credit counseling agency distributes the monthly payment between the consumer’s enrolled creditors until the debts are fully repaid.
So in essence, a DMP provides a structured debt repayment plan with better terms negotiated by the credit counseling agency. This allows consumers to get out of debt faster by saving on interest.
How Does a Debt Management Plan Work?
Here is an overview of how the debt management process typically works from start to finish:
1. Customer Enrolls with a Credit Counseling Agency
The process begins when the customer engages the services of a credit counseling agency and requests to start a DMP. They will provide details on their debt situation during the initial consultation.
2. Credit Counseling Agency Analyzes Debts
The credit counselor reviews the consumer’s debts and budgets to determine if a DMP is appropriate. The counselor proposes a monthly payment that the consumer can afford based on their disposable income.
3. Terms Are Negotiated with Creditors
Once enrolled, the agency works on the consumer’s behalf to negotiate reduced interest rates, waived fees, and a single monthly payment with each creditor.
4. Customer Makes Monthly DMP Payment
The consumer makes one monthly payment to the credit counseling agency, which distributes funds to each creditor per the negotiated DMP terms.
5. Creditors Apply Payments and Update Accounts
Creditors apply the distributed payments and update the customer’s accounts to reflect the new DMP terms. Interest and fees are waived moving forward.
6. Debt Balances Are Paid Down
As the customer continues making their consolidated monthly DMP payment, their debt balances gradually decrease until everything is repaid by the end of the DMP term.
7. Accounts Show as Paid/Closed Once Repaid
After the final payment distributions, the consumer’s accounts will show as paid-in-full or closed with a $0 balance, indicating debts have been repaid under the DMP.
This is the standard debt management plan process from start to finish. The entire DMP term often takes 3-5 years depending on the amount of debt enrolled.
DMP Pros and Cons
Debt management plans offer some benefits but also have drawbacks to consider. Here is an overview of the key pros and cons.
Pros of Debt Management Plans
Lower Interest Rates
The credit counseling agency negotiates reduced interest rates on debts enrolled in the DMP, often as low as 0-6%. This saves money compared to high credit card rates.
Lower Monthly Payments
The consolidated DMP payment is lower than the total minimum payments due across multiple accounts. This helps create a more affordable monthly budget.
One Simple Payment
You make a single payment to the credit counseling agency instead of juggling multiple credit card payments. This simplifies the repayment process.
Save Money on Interest
Thanks to lowered rates and a term long enough to pay debts in full, total interest paid is reduced compared to making minimum payments.
Waived Fees
Late fees, over-limit fees, and other penalty fees are waived by creditors once enrolled in a DMP. This avoids further cost increases.
End Collection Calls
The DMP stops collection calls from creditors seeking payments since the credit counseling agency takes over communications.
Avoid Bankruptcy
The DMP allows you to repay debts in full and avoid the severe consequences of bankruptcy. Your credit still suffers, but not as badly.
Certified Counselors
Non-profit credit counseling agencies have certified counselors who can provide budgeting assistance and advice.
Controlled Payoff
By enrolling in a multi-year structured DMP, you take control of a payoff strategy rather than haphazardly managing debts.
Cons of Debt Management Plans
Fees for DMP Services
You have to pay fees to the credit counseling agency for administering the DMP. This ranges from $0 to $75 per month.
Credit Score Damage
DMPs negatively impact your credit since accounts show enrolled in a repayment program. Scores can drop 100 points or more.
Repayment Term
It takes 3-5 years to complete a DMP, so you deal with reduced available credit and lower scores during this time.
Interest May Still Accrue
For debts not enrolled in the DMP, interest will continue growing unless you make payments.
No Guaranteed Approval
Creditors are not obligated to accept the proposed DMP terms, although most eventually will.
Potential Tax Implications
If creditors write off remaining balances after DMP completion, this canceled debt may be taxable.
Voluntarily Increasing Debt
You cannot continue charging more debt on accounts enrolled in the DMP. This reduces available credit.
As you can see, DMPs provide major benefits like reduced interest and simplified payments. However, the process comes with costs and credit damage. Evaluate the pros and cons carefully for your situation.
DMP Eligibility and Requirements
Debt management plans are not suitable for everyone struggling with debt. Certain eligibility requirements must be met:
- Debts are unsecured – DMPs apply only to unsecured debts like credit cards, medical bills, personal loans, and collections. Secured debts cannot be enrolled.
- Credit score of at least 450 – This demonstrates at least a minimal credit profile. Those with scores below 450 often have limited open accounts.
- Sufficient disposable income – After living expenses, you must have at least $50-100 in monthly disposable income to contribute toward the DMP.
- Accounts not severely delinquent – Accounts more than 6 months past due are less likely to be approved for a DMP by creditors.
- Willingness to close accounts – To avoid further charging, you must be willing to close enrolled credit card and line of credit accounts.
- Commitment to 3-5 year process – You must be capable of and willing to complete the 3-5 year DMP process.
If you meet these eligibility standards, a credit counseling agency can determine if a DMP is viable for your specific debts based on an analysis of your accounts, income, expenses, and credit.
How to Enroll in a Debt Management Plan
If you decide a DMP is right for you, here are the steps to enroll with a credit counseling agency:
1. Find a Reputable Agency
Only work with respected national non-profit credit counseling agencies like NFCC members. Avoid any company promising unrealistic results or charging very high fees.
2. Complete Initial Consultation
Schedule a free consultation with the agency to review your complete financial situation. Be prepared to provide details on income, budget, expenses, and debts.
3. Determine Eligibility
The credit counselor will analyze your information to determine if a DMP is likely to be approved by your creditors and benefit your situation.
4. Review Proposed DMP Terms
If eligible, the counselor will outline the proposed debt management plan including the monthly payment, fees, and other key terms. Make sure you agree and can afford the payment.
5. Formally Enroll in the DMP
To start the process, you’ll complete an application and agreement authorizing the credit counseling agency to communicate with your creditors and set up your DMP.
6. Close Enrolled Accounts
Remember, you must close credit card and line of credit accounts enrolled in the DMP to avoid increasing those balances. Leave open accounts unaffected by the DMP.
Once enrolled, the credit counseling service will handle contacting your creditors, negotiating better terms, consolidating payments, and managing the DMP on your behalf.
How Does a DMP Affect Your Credit Score and Reports?
A key downside of debt management plans is the negative impact they will have on your credit standing. Here’s how DMPs affect credit:
- Enrollment shown on credit reports – The DMP will be reported and notated on your credit reports when accounts are enrolled, signaling you are having financial difficulty.
- Closed accounts – Closed credit cards and lines of credit will lower your total available credit and increase utilization ratios. This brings down credit scores.
- Less mix of credit types – With closed revolving accounts, your mix of credit types shrinks and diversity of credit scores falls.
- Lower account ages – Closing old accounts lowers your average age of credit history, further reducing scores.
- Less on-time payments – With accounts closed, you have fewer accounts reporting on-time payments each month, decreasing positive credit building.
- Potential late payments – If any payments distributed by the agency are late, this results in additional negative credit reporting.
- Lower credit scores – For all these reasons, expect your credit scores to drop by 100 points or more when starting a DMP.
The DMP will show on your credit reports throughout the repayment term, indicating you are in a financial hardship program. Accounts will notate they were closed and enrolled in a DMP.
What Happens If You Don’t Pay Your DMP?
To complete a debt management plan successfully, you must continue making the agreed-upon consolidated monthly payments to the credit counseling agency on time. Failure to do so can lead to the following:
- Late fees – Just like a regular late payment, your credit counseling agency may charge a late fee if your DMP payment is not received by the due date.
- Increased interest rates – Creditors can end your negotiated low DMP interest rates and revert rates back to original higher amounts.
- Reinstated fees – Late fees, over-limit fees, and other penalties waived under the DMP may be charged again by creditors.
- Default reported – After two or more consecutive missed DMP payments, accounts may begin reporting missed payments, further damaging credit.
- Canceled DMP – After missed payments, creditors can withdraw from the DMP terms and revert your accounts to their original states. The DMP may be canceled entirely.
- Debts Due In Full – If the DMP is canceled due to non-payment, your debts become immediately due in full based on the original account terms.
- Collections – Accounts removed from the canceled DMP will be sent to collections if you become past due or stop making payments. More credit damage occurs.
To avoid these negative outcomes, always prioritize your DMP payment and contact your credit counseling agency immediately if you anticipate issues making any monthly payments. Do not let your DMP get canceled for non-payment.
Debt Management Plan vs. Debt Consolidation Loan
A common alternative to debt management plans is debt consolidation loans. How do consolidation loans compare?
Debt Consolidation Loans
- Take out a new loan to pay off existing debts
- Combines debts into one monthly loan payment
- Requires good credit for approval
- Unsecured or home equity loan options
- Rates often higher than DMP rates
Debt Management Plans
- Work with agency to get new repayment terms
- Also consolidates debts into one payment
- Can be an option for those with mediocre credit
- Always unsecured debts like credit cards
- Usually reduces interest substantially
For consumers with very good credit, a debt consolidation loan with a lower market rate can make sense. For others, a DMP provides more affordable repayment terms but with credit damage.
Debt consolidation loans also complete faster, often in 2-3 years versus 3-5 years for a DMP. This must be weighed against the pros and cons of each option carefully.
Debt Management Plan vs. Debt Settlement
Another choice is entering a debt settlement program. How do DMPs and debt settlement compare?
Debt Settlement
- Allows you to repay debts at reduced lump sum settlements
- Typically pays back 30-50% of balances
- Fees based on amount of debt relieved
- Major negative impact on credit
- Settled accounts show “paid less than agreed”
Debt Management Plans
- Pays back 100% of debt enrolled
- Lower interest, no fees, consolidated payment
- Smaller impact on credit than settlements
- Enrolled accounts show as paid or closed
- Takes 3-5 years to repay in full
A DMP allows you to repay debts fully while saving money on interest. Settlement provides a steep discount on debts but with severed credit impacts. DMPs take longer but avoid settled accounts on your report.
If credit score impacts are a top concern, a DMP likely makes more sense than aggressive debt settlement with balance reductions.
Debt Management Plan vs. Bankruptcy
Bankruptcy is a legal proceeding that provides the most extreme form of debt relief:
Bankruptcy
- Eliminates most unsecured debts entirely
- Closes all accounts reported in bankruptcy
- Assets may be liquidated and sold
- Most severe credit impacts
- Public records stay on report 10 years
Debt Management Plans
- Allows for full repayment of debts
- Voluntarily closes accounts to avoid more debt
- Enrolled accounts remain open until repaid
- Softer hit to credit than bankruptcy
- DMP notations eventually removed
Bankruptcy provides the chance for a fresh start by discharging unsecured debts. However, it should only be pursued as an absolute last resort due to the lasting credit damage. A DMP allows full repayment without public records and court filings.
Are DMP Payments Taxable?
In some cases, debt management plans may have tax implications that should be considered:
- Settled debt – If balances are ultimately settled for less than owed after a DMP, this canceled debt may be taxed as income. You may receive a 1099-C.
- Solvency considerations – If creditors reduce debt due to your insolvency, this is generally not taxable. Consult a tax expert.
- Interest paid – Interest paid on debts in a DMP is still deductible on your taxes just like before enrollment.
- Tax planning – Work with a tax professional to minimize any potential negative tax consequences from a DMP.
Always be aware of potential tax issues when debts are reduced, settled, or canceled after a debt management plan. Proper tax planning can help mitigate tax costs.
Alternatives to Debt Management Plans
A DMP is not the only option for addressing overwhelming amounts of debt. Alternatives to consider include:
- Debt consolidation loans – Take out a new loan to repay debts and reduce interest
- Credit counseling only – Work with a CCA for budgeting help and advice without a DMP
- Debt settlement – Negotiate lump sum payoffs equal to a percentage of balances
- DIY debt payoff – Create your own debt payoff plan and approach creditors yourself for better rates
- Bankruptcy – Pursue legal proceedings to discharge eligible debts and start fresh
- Home equity loan – Use home equity to repay high-interest unsecured debts
- Balance transfer card – Transfer balances to a new card with 0% intro APR to save on interest
Compare all options including the pros, cons, credit impacts, and costs before deciding if a debt management plan is your best course of action.
To Recap
Debt management plans through reputable credit counseling agencies provide a viable debt relief solution for some consumers overwhelmed with high-interest credit card and other unsecured debts. By consolidating accounts into one affordable monthly payment under better terms negotiated with creditors, DMPs allow for full repayment over 3-5 years without the devastation of bankruptcy.
However, debt management plans also come with drawbacks like fees, closed accounts, credit damage, and tax implications in some cases. Overall, a DMP can be an appropriate strategy for committed individuals who meet eligibility requirements and want professional guidance developing a reasonable debt repayment plan. But examine your options thoroughly and understand the process fully before enrolling so you know what to expect.
With this comprehensive guide detailing how debt management plans function, the pros and cons, what happens when you default, and alternatives to consider, you now have an understanding of everything involved with DMPs. You are equipped with the knowledge to determine if starting a debt management plan is your best path forward on the road to restoring financial stability.
Debt Management Plan FAQs
Here are answers to some frequently asked questions about debt management plans:
What is a debt management plan (DMP)?
A debt management plan is an agreement between a debtor and a credit counseling agency to consolidate debts into more affordable monthly payments and repay under better terms negotiated with creditors.
How does a DMP work to pay off debts?
The credit counseling service negotiates with your creditors to reduce interest, waive fees, and allow repayment with one monthly consolidated payment over 3-5 years until debts are fully paid.
What are the requirements to qualify for a debt management plan?
Typical requirements include having unsecured debt balances, a credit score over 450, at least $50 in monthly disposable income, and willingness to close accounts and commit to the DMP.
How much does a debt management plan cost?
Expect to pay monthly DMP administration fees of $0 to $75, depending on the specific credit counseling agency used. There may also be small setup fees.
What happens if I miss a payment on my DMP?
Missing DMP payments can result in penalties like late fees, reverted higher interest rates, and canceled DMP terms if you become too delinquent on payments.
Can I still get approved for credit while in a debt management plan?
It may be difficult to get approved for major new credit due to the lowered credit scores and closed accounts from the DMP. You may only qualify for secured credit cards and loans.
Is debt forgiven after completing a debt management plan?
No, a DMP allows you to repay debts fully over time. Debt forgiveness only occurs if accounts are ultimately settled for less than the full balance after a defaulted DMP.
Are DMP payments taxable?
Potentially yes, if debts are settled or forgiven after a DMP. Canceled debt may be considered taxable income. Work with a tax pro regarding possible tax implications.
Can I enroll mortgage, student loans, or car loans in a DMP?
No, only unsecured debts like credit cards, medical bills, personal loans, and collections can be included in a debt management plan.
What types of services do credit counseling agencies provide?
Reputable credit counseling agencies provide services like debt and budget counseling, financial education, and setting up debt management plans. Beware any making unrealistic promises.
What happens to my credit score during a debt management plan?
Due to closed accounts, increased utilization, and the DMP notation, expect your scores to drop significantly when starting a DMP, often by 100 points or more.
Are there alternatives to completing a debt management plan?
Yes, you can also consider options like debt consolidation loans, balance transfer cards, debt settlement, bankruptcy, and DIY debt payoff methods.
Can completion of a DMP improve my credit?
Over time after finishing a DMP and keeping other accounts in good standing, the negative credit impacts will gradually diminish. But full credit restoration takes time.
