Debt Settlement vs. Debt Management Programs: What’s the Difference?

Man Reviewing Payments at Home

From student loans to credit cards, paying off debt can be an enormous struggle for many people. As debt piles up and becomes overwhelming, consumers may consider seeking outside help to get out of debt. When searching for solutions, debt management and debt settlement are terms that are often confused or used interchangeably. However, there are several fundamental differences to keep in mind before choosing one option over the other.

Debt Settlement

At first glance, debt settlement may seem like the better option. A debt settlement company has you stop paying your creditors as they negotiate a lower payment. Then, the debt settlement company pays the creditors on your behalf. Essentially, it seems like you save money and the debt settlement company takes care of getting the payments to your creditors for you.

The catch is that the lower payment they negotiate is lower than your full outstanding balance. This harms your credit score because you are not paying off the total amount. Typically with debt settlement, you only pay about 50% to 80% of the balance. Additionally, the debt settlement company does not pay your creditors while they are negotiating the lower payment, so you may begin to receive collection calls. The late payments then get reported to the three major credit bureaus (Experian, TransUnion and Equifax) and stay on your credit report for seven years. Regardless of whether your settlement is successful, your credit will be damaged.

Also, keep in mind if the debt is settled for less than the full balance, you may have tax implications because the debt that is forgiven will likely be reported to the IRS as income. Finally, you'll pay hefty fees for this service: You could be charged as much as 15% to 25% of the amount settled.

Debt Management

Debt management programs (DMPs) are administered by nonprofit credit counseling companies, as opposed to debt settlement companies, which are for-profit. In a DMP, the credit counseling company negotiates with your creditors to reduce your interest rates and fees, or lower monthly payments for you. You still pay off the principal amount, so your credit score is not impacted as it would be with debt settlement. Credit counselors will also help you to improve your money management skills and come up with a workable budget.

How to Find Credible Debt Management Services

It can be difficult to sort out the scammers from legitimate companies.

"Consumers should always do their research ahead of time to protect themselves," says Katie Ross, education and development manager at American Consumer Credit Counseling. "Before you commit to any debt management service, there are a few credentials you should ensure the company has."

Things to look for in a credible agency:

  • Nonprofit status is important when choosing a debt management service.
  • Check that the company's credit counselors are certified.
  • As a rule of thumb, the longer the company has been in business, the more likely it is to have reputable services.
  • If the company you are considering is a member of a national accreditation association, such as the National Foundation for Credit Counseling, it is probably a credible company.
  • The agency is licensed and bonded to do business in your state.
  • The agency charges reasonable fees. Research several different agencies to get a general idea of pricing.

The bottom line: Be on the lookout for companies that try to make money off your debt by charging you fees without offering real help. Choose a company that understands your situation and will work with you to reduce your debt without tanking your credit scores or taking advantage of you financially. While debt can be stressful and difficult to deal with, you should make a well-informed decision before choosing a debt settlement company or a debt management program.

Disclosure: This post was written by Madison Block, an employee of American Consumer Credit Counseling.