Debt isn’t always a bad thing. Sometimes taking out a loan is the best way to pay for a large capital asset like a house or car. And if you have a mortgage rate under 3%, your obligation is looking pretty good right now, with inflation hovering over 8%. In addition, millions of Americans use debt to pay for college, open a business, or finance a home repair without adverse effects.

However, debt can also be a cannon aimed directly at our financial well-being, especially when it’s high interest, like a credit card. Spending less won’t be a satisfactory answer if you rack up balances on credit cards. Therefore, a plan is needed when debt gets out of control. Many companies offer debt management plans to help struggling consumers bargain with creditors and manage their debt levels.

How Does a Debt Management Plan Work?

Debt management plans are kind of like a negotiation between the company offering the program and your creditors. The management company will reach out to the various lenders you owe and attempt to get concessions on your behalf. Lower interest rates, combining of monthly bills, and elimination of penalties and fees are just some of the items these companies attempt to negotiate.

Why would someone negotiate on your behalf? Because you’re paying them to do so! Debt management companies take over your obligation and become the defacto owner of your accounts. For example, if you have credit cards with high balances, the management company will take over these accounts, close them, and work with the card company to create a payment plan. The banks and lenders would instead get some money than no money, so they work with debt management companies to recover some of the money they’re owed while making concessions beneficial to the original borrower.

Once established, the accounts will be closed, and you’ll make a monthly payment to the debt management company, not separate payments to your individual creditors. Since you lose access to your credit cards, you’ll likely see your credit score take a hit and you may lose access to other types of financial remedies. Debt management plans can only cover unsecured debt too, so mortgages, student loans, and auto loans are ineligible for these programs.

Who Should Consider a Debt Management Plan?

A debt management plan isn’t the worst solution in the world, but it’s a time-consuming process that will limit your access to other financial products. Your lenders will zero out your accounts, so your credit score will drop. You also won’t be able to use your credit cards and must stick to the monthly payment structure laid out in the debt management plan. A debt management plan typically lasts anywhere from 36 to 60 months, so you must be prepared to stick to it.

Debt management plans most benefit those who lack other options to consolidate or reduce debt. For example, suppose you have obligations due to credit cards or high-interest personal loans. A debt management plan can get you out of the debt death spiral where payments only satisfy the interest and your balance doesn’t decline much over time. But, on the other hand, a management plan might not be your best bet if you have secured debt or manageable debt with a low rate.

Another thing to consider is the penalty for dropping out of the debt management plan. While you aren’t legally bound to finish the debt management plan once you start, the program does protect you from creditors and collectors. You pay a flat monthly fee to the management firm, which keeps the collectors off your back until the completion of the plan. Should the plan itself become unmanageable, you can drop it, but your creditors will return, and you’ll lose any concessions the management company was able to secure on your behalf.

Using Debt Management Plans Effectively

A debt management plan will limit your access to current credit lines and also prevent you from opening new ones while on the plan. Many creditors will cancel the concessions made to the debt management consultant if they notice new lines of credit popping up on your credit report. Additionally, not all debt management plans have consumers’ best interests at heart. Make sure you only reach out to reputable non-profit firms and credit counseling agencies.

The alternatives to debt management plans are often far more severe, like bankruptcy or debt settlement. While far from perfect, a debt management plan could create some breathing room if you find yourself overburdened. If you can consolidate high-interest debt on your own through a low-rate personal loan with a workable monthly payment, explore that option first. But if you feel like you’re drowning, work with your advisor to find an appropriate debt management agency.

Work With an Experienced Financial Advisor

Our knowledgeable financial advisors at Good Life Financial Advisors of Mt. Pleasant are here to help you plan your investments and debt management. Contact us today to speak to our consultants and learn more about the tools and guidance we offer.

Disclosures

The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.