Many military families need help with managing their debt. Although some people are able to buckle down and work their way out of debt, others may need external help. A debt management plan is one of the most common resources people turn to.
A debt management plan is a relationship that you establish with a counseling agency that might be able to negotiate a lower payment or lower interest rate to your creditors. In exchange, you pay the agency, which then pays the creditors directly. All this is done for a nominal setup fee, as well as a monthly fee to continue the plan, which usually lasts from 36-60 months.
Before you sign up, there are several things you should consider before entering into a debt management plan.
What You Need to Know About Debt Management Plans – And How They Impact You
Debt management plans sound good on paper. You make one payment, and the company doles out the payments to each of your loans. You no longer have to worry about budgeting for multiple payments on different dates and you don’t have to worry about late payments. You might even have your total payment amounts lowered. Problem solved. Right?
Unfortunately, probably not.
There is No One-Size-Fits-All Debt Management Plan
Many providers who administer debt management plans seem to push a boiler-plate solution to anyone who might be able to afford it. This happens even if a debt management plan is not the right solution for that person’s particular situation. Some people might not need a debt management plan, while others might have debts that cannot be covered. For example, secured debts (car loans or mortgages) cannot be covered under a debt management plan. Before you sign up, you’ll want to make sure that a DMP is a right solution for your particular situation.
Debt Management Plans Have Fees
You might save money by paying less in credit card interest. However, that’s a small consolation if Debt Management Plan fees cancel out your savings. You can expect to pay an initial fee, as well as monthly fees for as long as you’re in the program. According to military.com, you should avoid plans that require an initial fee higher than $50, or monthly fees higher than $25.
Your Credit Score Will Likely Decrease With a Debt Management Plan
First of all, if you sign up for a debt management plan, you can expect some (or all) of your credit card providers to do any of the following:
- Stop extending you credit
- Not allow you to open new credit accounts
- Not allow you to use your credit card at all
When credit card companies start to close your accounts, the credit agencies reflect that as a lower amount of available credit. This is what lowers your score.
Second, creditors have been known to report to credit agencies that you’re not making the full agreed-upon payments. This might occur even after the creditors accept the reduced payment as part of your debt management plan. Keep your eyes on your credit report while you’re in a DMP so you know what’s happening. You’ll want to be in constant communication with your credit counselor on next steps if you notice something wrong with your credit report.
Debt Management Plan Completion Rates Are Low
Although debt management plans are supposed to last 36 to 60 months, most people quit before the program ends. This means they’ve paid the fees and may have already had their credit accounts frozen. However, they’ll eventually have to start their plan over to pay down that debt or otherwise file bankruptcy.
Perhaps it’s optimistic to think that these people may have finished the program early, or started paying it off on their own. Cambridge Credit Counseling, a leading DMP provider, states that 38% of its clients leave due to either bankruptcy or financial problems.
You Can Probably Achieve the Same Goal on Your Own
First of all, you’ve got to determine whether you’re serious. If you know that you’re going to set aside as much money as possible to pay down your debt and get back into the black, then you should look into whether you actually need a DMP.
You might find that with a little work and discipline, you can get the same effects (lower payments, gradual debt payoff) without having to rely upon a credit counselor.
Below are a couple of options:
1. Transfer your credit card debt to a 0% credit card
If you currently have a lot of high interest credit card debt, you might be able to transfer your balance to a zero-interest card, which will significantly reduce the amount of interest you are paying and make it faster and easier to repay your debt.
Many credit card companies offer an introductory 0% APR (annual percentage rate) for a certain period of time. You should know if there are any account transfer fees and exactly what period of time you’re able to do this. However, this might be a quick win if you’ve got one or two cards that you could pay off in a year or less.
Keep in mind that most balance transfer cards charge a fee to transfer the balance to the card. Even so, a 3-5% fee is substantially lower than the interest rates on many credit cards, which often exceed 20%.
You can also contact your credit card company to negotiate a lower rate. This could work especially in cases where you can demonstrate that you have a proven history with that credit card company and that you’ve paid your bills on time. Most companies will work with their valued customers to prevent them from moving their accounts.
2. Debt Consolidation with a Home Equity Line of Credit
You could use a lower-interest form of debt, such as home equity. However, using a home equity line of credit (HELOC) may encourage you to make bad decisions. Most people have great intentions but fail to follow through after the first few months. A HELOC shouldn’t be seen as a substitute for emergency savings.
A Home Equity Line of Credit (HELOC) is a flexible line of against the value of your home – you use your home’s equity as collateral. HELOCs should be used with caution because you are using your home as collateral. But you can save a lot of money on interest when you use a HELOC as a tool to consolidate debt and not enable spending. The interest rate you can get on a HELOC depends on many factors including current interest rates, your credit history and score, and other factors. With a strong credit score, you can currently find HELOCs in the low 5% range, and they go up from there.
3. Lending Club and other peer-to-peer lending companies
Lending Club is currently the leader in the peer-to-peer lending company, which allows regular folks such as you and me to request a loan that is funded by other regular folks. Lending Club just acts as the middle man and facilitates the loans. P2P loans are a good way to obtain a personal loan for whatever you need it for, including bill consolidation loans, home improvements, major purchases, etc. Lending Club also offers people a way to do online investing in a secure manner.
Other debt consolidation options
There are other debt consolidation options, but the three options listed above are the best for many people. Other options include refinancing your home and withdrawing equity, making a withdrawal from your 401k or other retirement accounts, or getting a home equity loan (similar to a HELOC, but it is a one-time loan and is not as flexible). These options present more drawbacks than the options listed above and can prove to be more expensive than they are worth.
Debt consolidation is a chance to start over – don’t blow it
Debt is expensive, and if you are considering a debt consolidation loan, you recognize that you need to eliminate your debt once and for all. If you are able to secure a debt consolidation loan at a lower interest rate, then take advantage of it. Stop borrowing new money, cut up your credit cards, and repay your debt as quickly as possible.
Fortunately, in the military, you don’t even need to try this on your own. You’ve got other available options before you resort to a debt management plan. You should definitely talk to your installation’s financial counselor before making any type of commitment into a DMP. Your financial counselor will give you an honest assessment and help you make the right decision for your situation. While this may or may not include enrolling in a debt management plan, you can rest assured that your advice comes from someone who doesn’t have a conflict of interest.