By Ben Luthi
Edited by Michelle TipswordWhat’s the Difference Between Debt Settlement and Debt Management Programs?
Quick Answer
Both debt settlement and a debt management plan can provide you with some relief from debt. But both options carry some costs and risks, and it's important to know your situation and research all your options to determine the best strategy.
If you're overwhelmed by credit card balances or other unsecured debts, you may have heard about debt settlement and debt management plans as potential solutions. While both programs aim to help you get out of debt, they work in very different ways—and the impact on your finances and credit can vary significantly.
Here's what you need to know about debt settlement versus debt management, including how each program works, the costs involved and the potential effects on your credit.
| Debt Management | Debt Settlement | |
|---|---|---|
| Purpose | Repay your full debt through a structured payment plan, often with reduced interest rates | Negotiate with creditors to pay less than the full amount you owe |
| Credit score impact | Closing your credit cards can cause your utilization rate to spike, hurting your credit score until you pay off the debt | Missing payments during the negotiation process can damage your credit score, as can the settlement itself; these items remain on your credit reports for seven years from the original delinquency date |
| Timeframe | Typically three to five years | Typically two to four years, though it can vary based on your debts and ability to save funds |
| Cost | Typically requires an initial setup fee of $25 to $75 and a monthly fee ranging from $20 to $70 | Debt settlement companies may charge 15% to 25% of the debt amount; creditors may tack on late fees and collection charges if you stop making payments; forgiven debt may be subject to income taxes |
| Best for | People who can afford monthly payments but need lower interest rates and a structured repayment plan | People facing financial hardship who cannot afford to repay the full debt amount |
What Is a Debt Management Plan?
A debt management plan (DMP) is a structured repayment program administered by a credit counseling agency. Through a DMP, you work with the agency to create a plan to pay off your unsecured debts (typically credit cards) over a set period of time, usually three to five years.
The credit counseling agency may negotiate with your creditors on your behalf to secure lower interest rates and monthly payments, making your debt more manageable. Unlike debt settlement, a DMP requires you to repay the full amount you owe.
How Does a Debt Management Plan Work?
Here's the general process for enrolling in and completing a debt management plan:
- Get a credit counseling session. Contact a nonprofit credit counseling agency to review your financial situation. The counselor will assess your income, expenses and debts to determine if a DMP is right for you.
- Enroll in the program. If you decide to move forward, you'll pay a setup fee (typically $25 to $75) and enroll in the DMP.
- The agency negotiates with creditors. Your credit counselor will contact your creditors to negotiate lower interest rates and monthly payments. Not all creditors are required to accept these terms.
- Make a single monthly payment. Instead of paying multiple creditors, you'll make one monthly payment to the credit counseling agency, which distributes the funds to your creditors on your behalf.
- Pay a monthly service fee. You'll typically pay a monthly fee ranging from $20 to $70 to the credit counseling agency for managing your plan.
- Complete the program. Most DMPs take three to five years to complete. Once you've paid off all enrolled debts, the program ends.
It's crucial to stick to your payment schedule throughout the program. Missing payments can cause creditors to revoke the concessions they've made, and you could be removed from the program entirely.
Learn more: Can Your Lender Reject Your Debt Management Plan?
Pros and Cons of Debt Management Plans
Debt management can provide you with some payment relief and protect your credit score, but it can do short-term damage to your credit and impact your spending power.
Here are some benefits and drawbacks to keep in mind when deciding if a debt management plan is right for you.
Pros
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Doesn't cause lasting credit damage: While some aspects of a DMP can negatively impact your credit, it won't create yearslong damage like debt settlement or bankruptcy. In fact, a DMP can help you improve your credit score over time by helping you stay on top of making on-time payments.
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Provides payment relief: With a reduced interest rate and lower monthly payment, you could save a lot of money and may have an easier time sticking to a repayment plan. Only having one monthly payment can also make the process simpler.
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Has a set repayment term: Credit cards don't have structured repayment terms, which can make it more challenging to pay them off quickly. With the structure of a DMP, you'll have a better idea of when you'll be debt-free.
Cons
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Can damage your credit in the short term: You'll likely be required to close your credit card accounts when including them in a DMP, which can cause your credit utilization rate to spike. As a result your credit score could drop, though not as drastically as with debt settlement or bankruptcy. The good news is that your credit score will recover as you pay down your balances.
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No new credit: You typically can't open new credit accounts when you're on a DMP. If you've relied on credit cards and other forms of credit to get by, this can significantly impact your spending power.
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May not be cheap: Agencies charge an upfront fee to set up a DMP and ongoing monthly fees, and depending on which agency you work with, you may end up paying more than you need to. Ensure you're working with a reputable nonprofit agency by searching for a credit counselor through the National Foundation for Credit Counseling or the Financial Counseling Association of America.
What Is Debt Settlement?
Debt settlement is a process where you or a company negotiates with your creditors to pay less than the full amount you owe. You can attempt to settle debts on your own by contacting creditors directly, or you can hire a debt settlement company or law firm to negotiate on your behalf.
Unlike a debt management plan, which requires you to repay your debts in full, debt settlement aims to reduce the total amount you owe. However, the process can take a significant toll on your credit and may result in additional fees and tax consequences.
How Does Debt Settlement Work?
If you're considering debt settlement, here's what the process typically looks like if you go through a debt settlement company:
- Enroll with a debt settlement company. You'll provide information about your debts and financial situation to determine if debt settlement is a viable option.
- Stop making payments to creditors. The company will typically instruct you to stop paying your creditors directly. This causes your accounts to become delinquent, which can damage your credit score and result in late fees and collection activity.
- Deposit money into a dedicated account. Instead of paying creditors, you'll make regular deposits into a special account controlled by the debt settlement company. This money will be used to fund settlement offers.
- The company negotiates with creditors. Once enough funds have accumulated, the debt settlement company will contact your creditors to negotiate a reduced payoff amount. Creditors are not obligated to accept settlement offers.
- Pay the settlement amount. If a creditor agrees to settle, you'll pay the negotiated amount—usually anywhere from 10% to 70% of what you originally owed—as a lump sum from your dedicated account.
- Pay fees to the settlement company. Debt settlement companies typically charge 15% to 25% of the total enrolled debt amount for their services.
Keep in mind that forgiven debt may be considered taxable income by the IRS, meaning you could owe taxes on the amount your creditor wrote off.
Learn more: Risks of Debt Settlement
Pros and Cons of Debt Settlement
Debt settlement can be worth considering as an alternative to bankruptcy, especially if you're already behind on payments and much of the damage has already been done. However, the process can be expensive, and there are some significant risks to keep in mind.
Pros
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Can provide relief in a dire situation: If you're overwhelmed and other debt repayment options, including debt consolidation and DMPs, aren't feasible, debt settlement could help you get out from under a significant financial burden.
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Helps you avoid bankruptcy: While debt settlement can do more damage to your credit history than a DMP, it won't be as bad as bankruptcy.
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Can prevent other consequences: If you can negotiate a settlement with your original creditor, you may be able to avoid having the debt sent to collections, which can compound your credit issues. Settling with a debt collection agency can also save you from a lawsuit, which could result in wage garnishment and other drastic measures.
Cons
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Can be costly: If you hire a debt settlement company or law firm, you may have to pay a hefty fee for their service, reducing your savings. If you stop making payments during the negotiation process, the creditor may add late payment charges and collection fees to your balance, increasing how much you owe. Finally, if the creditor does forgive a portion of your debt, you may need to report the amount as income on your tax return, which could result in a tax bill.
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Can deeply harm your credit: A debt settlement indicates that you didn't pay as originally agreed, and because your payment history is the most important factor in your FICO® ScoreΘ, it can be devastating for your credit profile. A settlement will remain on your credit reports for seven years from the original delinquency, so if you're already behind on payments, much of the damage may have already been done. But if you're still paying on time, consider other options.
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No guarantee it'll work: Because you have a contract with your lender, it has the right to refuse your attempt to settle. In fact, some creditors may have a policy against working with debt settlement companies and law firms. Even if you do get a creditor to come to the table, settling may not get you the savings you're hoping for.
How to Choose Between Debt Management and Debt Settlement?
The right option depends on your financial situation and ability to repay your debts.
A debt management plan may be right for you if:
- You can afford to make monthly payments but need lower interest rates.
- You want to avoid severe credit damage.
- You prefer to repay your debts in full.
- You have a steady income to support a three- to five-year repayment plan.
Debt settlement may be right for you if:
- You're facing serious financial hardship and can't afford to repay your full debt.
- You're already behind on payments or considering bankruptcy.
- You can save enough money to make lump-sum settlement offers.
- You're willing to accept significant credit damage in exchange for reducing your total debt.
Alternatives to Debt Management and Debt Settlement
If neither debt management nor debt settlement feels right for your situation, consider these other debt repayment strategies:
- Debt consolidation loan: If you have good credit, you could take out a debt consolidation loan, a type of personal loan, to pay off multiple debts. This leaves you with one monthly payment and potentially a lower interest rate.
- Balance transfer credit card: Transfer high-interest credit card balances to a card offering a 0% introductory APR period, allowing you to pay down debt without accruing interest. Just note that good credit is usually required.
- Debt avalanche or snowball method: Pay off debts on your own using either the avalanche method (highest interest rate first) or the snowball method (smallest balance first).
- Negotiate directly with creditors: Contact your creditors yourself to request lower interest rates, reduced payments or hardship programs.
- Bankruptcy: Consider Chapter 7 or Chapter 13 bankruptcy if you're facing overwhelming debt and other options won't work. This should be a last resort due to its severe credit impact.
Learn more: How to Get Out of Debt
The Bottom Line
Before you consider a debt management plan or debt settlement, take stock of your situation and research your debt repayment options. If you have great credit and room in your budget, for instance, a balance transfer credit card or debt consolidation loan may be worth considering. You can also look into accelerated repayment strategies.
On the other end of the spectrum, bankruptcy may be your only option if your financial situation doesn't make anything else possible.
Check your credit score before you proceed to better understand your options. If you're overwhelmed, consider consulting with a credit counselor who can evaluate your situation and provide personalized advice, often free of charge.
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About the author
Ben Luthi
Ben Luthi has worked in financial planning, banking and auto finance, and writes about all aspects of money. His work has appeared in Time, Success, USA Today, Credit Karma, NerdWallet, Wirecutter and more.
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