Is a Debt Management Plan a Good Idea?
Article by R. Joseph Ritter, Jr. CFP® EA
Let’s begin with a caveat. Zacchaeus Financial Counseling, Inc. does not engage in or endorse credit counseling, credit repair, debt relief, debt settlement and similar services. These services are heavily regulated, and for good reason. It has significant potential to damage your credit, often involves payment of debts into a “trust account” of a third-party who then pays your creditors on your behalf, and can land you in a worse position if not done correctly. If you want to ensure your creditors are paid in this type of situation, then you must have assurances that the organization is legitimate and financially sound, especially if they place your money in escrow or trust account. There are times when credit counseling can help to improve your credit, however, other regulation already covers the length of time damaging items may remain on your credit. Therefore, if you embarked on your own, careful journey, you could conceivably arrive at the same or better place as a credit counselor could produce for you. This makes credit counseling something which no one should take lightly and always be very suspicious of potential fraud.
With that out of the way, let’s discuss the topic: What is a debt management plan (DMP)? The long and short of it is a DMP restructures the terms of your debt. The DMP arranges for a payment plan over a specific time period, negotiates interest rates with your creditors, may negotiate balances with your creditors, and often arranges for the accounts to be closed. The theory behind a DMP is two-fold.
First, if you need help managing debt, your credit has probably already been damaged. Although the DMP initially creates further damage to your credit, the DMP also provides a mechanism for you to repay your debts and begin to rebuild your credit. Second, the DMP can offer relief from collections, high interest rates, and unmanageable payments.
If you are diligent and disciplined, which you need to be anyway, you can accomplish the same thing on your own. However, your creditors will likely want to interview you and review your monthly income and expenses. Basically, they want to know that you can pay under the new repayment terms. If you use a DMP, your creditors are taking the DMP sponsor’s word that you are a worthwhile debtor.
That leads us to the job of the DMP sponsor. The Federal Trade Commission and U.S. Trustee Program, which is an arm of the U.S. Department of Justice, regulate credit counseling, in addition to most, if not all, state governments. These regulations require that the DMP sponsor help you with budgeting and offer ongoing assistance to help you stay on track. The federal government and state attorneys general warn you not to work with a credit counseling agency that only wants to do a DMP without assisting you with budgeting. Creditors rely on these regulations before accepting a DMP proposal, and you can imagine the harm which results from doing a DMP without the budgeting aspect. The federal government goes further and recommends that you only work with credit counseling agencies which provide ongoing budgeting help and guidance. The recommendation protects both you and the creditor.
In other words, to make the DMP successful, you must have a budget that works, use effective budgeting controls and make wise decisions with your money throughout the duration of the DMP. One reason for this is that being unable to successfully complete the DMP puts your credit at further risk of damage and quickly thrusts you right back into the position you were before signing up for the DMP – high interest, unmanageable payments, etc. Credit counseling agencies are doing you a disservice if they do not help you with budgeting.
One final note is that credit counselors don’t work for free. There are fees associated with the DMP. Those fees may be paid by your creditors … and they may not. One common method of payment is to collect a higher amount from you than the agency pays to the creditor. For example, if your creditor agrees to accept 70% of the balance as payment in full, the DMP sponsor may collect 75% from you and keep the 5% difference as payment of their fees.
As a CFP® Professional, R. Joseph Ritter, Jr. CFP® EA of Zacchaeus Financial Counseling, Inc. provides a comprehensive review of your situation to determine what is possible and whether a particular strategy will work best for you. If you need help formulating a debt payment strategy, we can certainly assist you with developing an effective budget and advocating for you with creditors.