Pros and Cons of Debt Management Plans

Learn about the upsides and downsides to debt management plans and get information about how to steer clear of related scams.

By , Attorney · University of Denver Sturm College of Law

Companies that offer debt management plans work with you and your creditors to develop a strategy to repay unsecured debts, like credit cards, medical debts, and other consumer debts. Often, companies offering debt management plans call themselves "credit counseling agencies."

While legitimate debt management plans might help certain people solve their financial difficulties, some of these programs can lead to more money troubles. Often, for-profit debt management agencies charge high fees for services that consumers can handle themselves, make promises they don't keep, and fail to pay creditors promptly (if at all).

Because many scammer companies offer debt management plans, you should be wary before signing up for this arrangement.

How Does a Debt Management Plan Work?

Here's how a typical debt management plan might work: You deposit money into an account every month, and the credit counseling agency uses the money to pay your creditors under the plan. Usually, you have to make regularly scheduled payments into the account for three to five years.

The terms of most plans require you to pay the debt management company a fee in addition to the monthly deposits.

Upsides to Debt Management Plans

The most significant upside to a legitimate debt management plan is that creditors typically agree to waive some fees and reduce interest rates as part of the program. Most creditors will make some concessions when you're on a good debt management plan. Eliminating the interest can significantly reduce the amount you owe each month.

Here are a few more advantages of using a legitimate debt management program:

  • You'll receive credit counseling, financial counseling, budgeting advice, and information about many options for getting out of debt.
  • A counselor works with your creditors, so you don't have to.
  • It's simpler for some people to make one consolidated payment each month to a debt management company instead of making payments to multiple creditors.
  • Participating in a debt management plan won't negatively affect your credit scores. In fact, making timely payments will typically improve your credit. But your credit reports will have a note that says you're enrolled in a debt management program. And entering into a debt management plan won't strike negative entries from your credit reports.
  • If you avoid bankruptcy by completing a debt management program, most negative items in your credit report will be reported for just seven years instead of up to ten years for a Chapter 7 bankruptcy. (A Chapter 13 bankruptcy, on the other hand, is reported for seven years.)

When Is a Debt Management Plan a Good Idea?

If most of your debt is unsecured, such as credit card debt, and you're struggling to make multiple, large monthly payments, you might benefit from a debt management plan. Under a debt management program, you must make a single, lower monthly payment.

But you must have enough income to make payments. Debt management plans generally work best if you have less severe financial difficulties. Otherwise, bankruptcy or debt settlement (modifying your repayment terms without a debt management plan) might be a better option. People sometimes attempt a debt management plan but end up filing for bankruptcy anyway because they can't keep up with the payments.

Also, a debt management plan might help if you're getting many debt collection calls. You won't receive calls from collectors on debts included in the plan. However, federal law allows you to stop collection calls even if you're not in a debt management plan.

Downsides to Debt Management Plans

Unfortunately, it's far too easy to fall into a debt management scam, sign up for services you really don't need, or end up paying money to a disreputable agency that could otherwise go directly to your creditors.

Falling Prey to a Debt Management Scammer

Some debt management companies are legitimate nonprofit credit counseling agencies, but many aren't. Common debt management scams and abuses by scammer credit counseling agencies include:

  • failing to pay creditors on time under the terms of the plan
  • not paying creditors at all and keeping the deposits you make
  • assuring you that they'll convince creditors to give you lower interest rates and reduced fees, but the company can't or won't keep this promise
  • charging high fees
  • exaggerating the amount of money you'll save with a debt management plan
  • lying about the company's nonprofit status and using this status to attract you, then funneling unreasonably high fees to a for-profit company, and
  • promising to provide financial advice and educational services, and then just automatically enrolling you in a debt management plan without providing any kind of counseling about other options, like filing for bankruptcy (see below).

Debt Management Plans Can Be Costly

Even if you're considering a debt management plan offered by a legitimate credit counseling company, you should still use caution before signing up for the service. Generally, debt management companies get paid either:

  • from creditors, who might voluntarily rebate a small percentage of the funds being paid by the consumer under the plan or
  • by charging the consumer fees, often called "contributions" or "donations," which can be high. (A legitimate credit counseling agency might waive its fees if your income is very low.)

When you pay an agency to help you with your debt issues, you're spending money that you could use to pay off your debts. Keep in mind that debt management companies often charge fees for services you might be able to do on your own, like contacting your creditors and working out individual payment plans or settlements. You might even be able to persuade your creditors to reduce fees, interest rates, and the principal amount that's due. You can then use the money you would have paid to the agency to pay down your debts faster or build up an emergency fund.

Before signing up for a debt management plan, you should explore all your other debt-relief options (including bankruptcy) and determine if the amount you have to pay to participate in the plan makes sense.

Debt Management Plan vs. Chapter 13 Bankruptcy

Participating in a credit counseling agency's debt management program is a little bit like filing for Chapter 13 bankruptcy. Working with a credit counseling agency has one advantage: No bankruptcy will appear in your credit files. But a debt management program also has two disadvantages when compared to Chapter 13 bankruptcy.

  • First, if you miss a payment, Chapter 13 protects you from creditors who could otherwise start collection actions immediately. A debt management program has no such protection, and any creditor can pull the plug on your plan.
  • Also, a debt management plan usually requires that your debts other than late fees be paid in full (with no interest or at a reduced rate). In Chapter 13 bankruptcy, the amount you have to pay depends on your disposable income and the value of your nonexempt property; you might end up paying back only a small percentage of your unsecured debt.

And, because major creditors, such as department stores, credit card companies, and banks often fund nonprofit credit counseling agencies, the agency might try to convince you to go with a debt management plan in which you fully repay your debts rather than filing for bankruptcy. If you're considering signing up for a debt management plan, you should also talk to a bankruptcy lawyer to make sure you get the full picture. You can also ask the attorney if you're eligible for a Chapter 7 bankruptcy, which could potentially eliminate most of your debts.

Other Downsides to Debt Management Plans

In addition, debt management plans only address unsecured debts (like personal loans and credit card debt), and your creditors must agree to participate. Credits aren't required to accept less than they're owed and are under no legal obligation to accept the plan.

You also probably won't be able to get new credit while you're in a debt management plan. Most prospective lenders will require your debt management plan administrator to provide an approval letter.

Laws That Protect Consumers From Debt Management Scams

Debt relief services, like credit repair, debt consolidation, debt settlement, and debt management plans, are advertised on the internet, radio, and television. But, in many cases, companies that offer these kinds of services are scammers who provide little or no help after you've paid them.

Even if a for-profit debt relief company does try to help you, you'll probably have to pay a lot for services you could do yourself or would be better off paying an attorney or legitimate credit counseling company. (Legitimate credit counseling agencies offer financial help for free or at a minimal charge.)

Fortunately, federal laws, like the Federal Trade Commission Telemarketing Sales Rule and some state laws, provide protection from scammer debt relief companies.

FTC Telemarketing Sales Rule

The FTC Telemarketing Sales Rule offers some limited protection against abusive for-profit debt relief companies. Among other things, the Rule:

  • prohibits covered debt relief services from collecting fees until the company settles, alters, or reduces the debt
  • requires particular disclosures when marketing debt relief services, and
  • prohibits specific misrepresentations.

The Rule only applies to for-profit companies, services related to unsecured debts, and services rendered after the debt relief company calls you or you call in response to an advertisement—not if the company communicates with you through the internet or the mail. The Rule also usually applies when the customer initiates a call in response to the company's advertisement through the mail or an email.

State Protections

Almost all states regulate debt relief companies, and some states prohibit debt settlement companies from doing business. These state laws usually don't apply to lawyers and nonprofits, though. State laws that regulate debt relief services often:

  • limit the fees that agencies can charge
  • require written contracts
  • require that the debt relief company keep consumer payments in a separate trust account
  • require debt relief companies to post bonds, and
  • restrict certain practices.

If, after you look into other forms of debt relief and consider the downsides of a debt management plan, you're still thinking about signing up for one, make sure you're dealing with a legitimate nonprofit credit counseling agency.

How to Find a Legitimate Nonprofit Credit Counseling Agency

Here are some tips for finding a reputable nonprofit credit counseling agency:

  • Ensure the company is accredited, usually by the Council on Accreditation (COA) or the International Organization for Standardization (ISO).
  • Consider using an agency that's a National Foundation for Credit Counseling (NFCC) member accredited by the COA.
  • The counselors working for the agency should be certified by an independent agency, meaning they've passed a certification exam that tests for understanding in counseling, budgeting, credit and consumer law, debt management, and bankruptcy.
  • Check for complaints filed against the company with your state attorney general's office, the Better Business Bureau, and local consumer protection agencies.

If you decide to proceed with a debt management plan, be sure to get everything in writing, including fees, and follow up with your creditors to ensure they're getting paid on time.

Hiring an Attorney

Attorneys provide many kinds of services to help people deal with their debts. Some of the most common debt-related services that attorneys provide are representing debtors in bankruptcy proceedings, debt management assistance, and negotiating with creditors to settle debts. (Be aware that if you settle a debt for less than you owe, you might face a tax liability. The IRS generally considers canceled debt of $600 or more as taxable unless you qualify for an exception or exclusion.)

If you want to learn more about filing for bankruptcy, talk to a bankruptcy lawyer. Talk to a debt settlement attorney to learn more about settling your debts. Debt settlement attorneys also sometimes provide other services to debtors, including defending against a collection lawsuit or disputing incorrect information on your credit report.

Many bankruptcy and debt settlement attorneys offer free consultations and will quote you a fee after evaluating your circumstances.

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