Understanding the Difference Between Debt Settlement and Debt Management
Published: February 15, 2022
Many of us might find ourselves with choices to make when figuring out how to manage debt, especially in the face of pressures from rising prices, or perhaps unexpected changes in household income.
If you’re trying to manage credit card payments and other debt in a challenging time, it’s helpful to get some background information to consider the best approach that works for you.
To help you weigh your options, here is an overview to highlight the difference between two approaches: debt settlement and debt management.
Chances are you have heard about debt settlement companies and their offerings.
Debt settlement companies are well-known. At a time of financial crisis or in the beginning of a New Year, there are even more debt settlement commercials online and on TV or radio. The process works like this:
- Debt settlement typically involves requesting credit card companies to forgive a portion of your debt in exchange for a lump sum payment.
- You provide the names of your creditors and the amount of outstanding bills to the debt settlement company.
- The debt settlement company then gives you an estimate for reducing your debt along with a new, lower monthly payment. As advised by the settlement company, you stop paying your creditors and instead send payments to the debt settler.
- Typically, your payments are held until enough funds accumulate to make a settlement offer to a creditor. In the meantime, your accounts could be falling farther past due resulting in stressful collection activity.
- Once funds accumulate the settler handles the negotiation with each creditor. This process happens over several years.
Costs of Debt Settlement
It’s helpful to take a close look at the costs involved when working with a for-profit debt settlement company.
Debt settlement companies charge 15 to 25 percent of your enrolled debt.
On top of this, forgiven debt may be considered taxable income, so you need to check with your tax professional.
So, if you settle a debt, you will pay your creditor the agreed lump sum, then pay a 15 to 25 percent fee to the agency, and then possibly a tax bill.
Impact on Credit Scores with Debt Settlement
A debt settlement firm may advise you to ignore all the missed payment notices sent to you by credit card issuers. Missed payments means your credit score will go down in the short-term.
Any missed payments remain on a credit report for seven years. Until you replace the negative payment history with some positive information, you’ll have difficulty getting new credit cards and loans.
Debt management programs through credit counseling take into consideration your total financial picture, from outstanding credit card payments to overall financial health.
With debt management, typically within 3 to 5 years people can achieve success which includes paying off debt, rebuilding credit and being able to work toward financial goals.
The goal of the program is for you to get out of debt in full, and reduce financial stress. In general, the process works as follows:
- After the counselor understands your specific situation, they work with you to build a debt management plan that consolidates your debt into a single payment.
- Your creditors are contacted immediately upon enrollment so they are aware of your situation, can note your account, and in many cases stop collection activity.
- The program works to ask your creditors for concessions such as lower interest rates and monthly payments with creditors, so if allowed you can pay off debt faster and save money.
- Each payday, you automatically deposit money into your account, and that money is then paid to your creditors on your behalf.
- Debt management plans are designed to pay off the entire amount you owe.
For those who team with a national nonprofit like GreenPath, a Debt Management Plan is delivered by NFCC-certified financial counselors who receive training in compassion and empathy. Each situation is unique – so counselors are trained to offer specific advice that meets each person’s needs.
Costs of Debt Management
With debt management, it is helpful to know that debt management from a nonprofit charges a nominal monthly fee, which is typically offset by lower rates and fees.
When a debt management plan can lower your interest rates, the total amount you pay to your credit card company is typically less than if you paid on your own.
Credit Scores with Debt Management
With debt management, your credit score may drop initially when your credit accounts are closed.
Typically, by the end of a debt management plan, your credit score rebounds because you will have reduced your debt load and you will have a consistent history of on-time payments.
Many people who participate in debt management learn to change spending habits and stay on track to pay off debt and build a healthy financial life.
To help figure it all out, many people gain clarity by calling a GreenPath financial expert. When you call, you’ll talk to one of our NFCC-certified counselors. We’ll review your financial situation together, and make a personalized plan to get your finances back on track.
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APR = Annual Percentage Rate