What’s the Difference Between Debt Management Programs and Debt Settlement Companies?

Feeling overwhelmed by debt? You’re not alone. Given the state of the economy and increases in the cost of living, lots of people are having trouble managing their budgets and repaying what they owe. The good news is there’s help available for those struggling to keep up.

Two popular approaches to resolving debt are debt management programs and debt settlement companies. Debt management programs seek to eliminate debt, includes counseling and financial education and is generally considered the safer route. To help you understand the differences between debt management programs and debt settlement companies, let’s take a closer look at how each works.

What are debt management programs?

Debt management programs (DMP) are credit counseling agencies set up to make it easier for people to repay debt. Their primary goal is to help you pay off your high-interest unsecured debts like personal loans or credit cards usually over a period of between 3 and 5 years. Utility bills, back taxes or secured loans like your car payment or mortgage typically don’t qualify.

Typical Debt Management Process

1. Consultation and credit counseling. After performing a detailed review of your finances, your certified credit counselor will help you create a reasonable budget, discuss your debt relief options and calculate a monthly payment you can afford.
2. Development of a personalized plan. Taking into account your income, expenses and debts, you’ll work together to settle on a personalized plan to pay off your unsecured debts.
3. Proposal and negotiation with creditors. Your counselor will contact your creditors on your behalf to negotiate for lower interest rates, waived fees and a defined amount of time to repay the full amount.
4. Creditor Agreement. Your creditors review the proposal and decide if the proposed terms are acceptable. Although debt management organizations can’t guarantee terms, most major lenders will agree to work with reputable debt management programs.
5. Program begins. Once agreements are in place, you’ll make a single monthly payment to the DMP instead of multiple payments to multiple creditors. The DMP will distribute the agreed upon amounts to your creditors.
6. Program completion. Most repayment plans last anywhere from 3 to 5 years. By the end of that time, your unsecured debts will be completely paid off. 

What are debt settlement companies?

Debt settlement companies take a different approach to debt relief. Like credit management companies, they negotiate with your creditors on your behalf. But, their goal is to reduce the total amount you’ll pay on your unsecured debts in exchange for a high fee. In simple terms, it means they’ll try to get your creditors to accept less than what you owe, while charging you a lot of money to do it. 

Typical Debt Settlement Process

1. Consultation. You’ll meet with your debt settlement representative to discuss how much money you owe and to whom. No counseling or financial education will be included with this service.
2. Plan development. Many of these companies will suggest you stop making regular payments to creditors and instead put money in an account managed by the debt settlement company. This could have a disastrous effect on your credit score.
3. Proposal to creditors. Once there's enough money in the account, the company negotiates with your creditors to accept a flat amount. This amount is often less than what you owe.
4. Creditor agreement. The truth is there are no guarantees that your creditors will agree to this proposal, especially since it’s likely they’ll have to settle for less than what they’re owed.
5. Debt settlement. The debt settlement company distributes the agreed upon amounts to those creditors who agree to their proposal. Those who don’t agree receive nothing.
6. Program completion. Most repayment plans last anywhere from 2 to 4 years. Once completed, your unsecured debts will be considered paid, but will be reported to credit reporting agencies as “settled for less than the full amount.”  These debts may also result in being “charged-off,” if no payments are made for months at a time. (Charging off means that your lenders may write off your debt as a loss and report it to the credit bureaus.) Both can harm your credit standing for years!

Does debt settlement hurt your credit score?

Yes! It’s crucial to understand that debt settlement comes with major risks.

• There’s no guarantee your creditors will agree to accept less than what they’re owed.
• There’s no guarantee you’ll save much, if any, money.
• Even if your creditors agree to the settlement company’s terms, they’ll report the debts to the credit bureaus as “settled for less than the full amount,” which will negatively impact your credit score.
• If you stop making payments, creditors can refer your debt to a collection agency, charge it off or file a lawsuit against you.
• Your credit score will take a big hit, which could mean you’ll have trouble qualifying for credit for several years.

Many view this option as a last resort before filing for bankruptcy. But, while the possibility of paying less than you owe may seem attractive, it’s a riskier approach. 

Be cautious of debt settlement companies that promise to settle your debts for pennies on the dollar or guarantee to make you debt-free in a short time. These claims are probably unrealistic and could be signs of a scam.

Pros and Cons: Debt Management Programs vs. Debt Settlement Companies

To help you better understand the key differences, let’s do a side-by-side comparison. 

Navy Federal Credit Union Can Help You Resolve Your Debt

Did you know that as a Navy Federal Credit Union member, you have access to free personal finance counseling? Whether you’re struggling with debt or just want some suggestions on how to improve  your finances, we can help. We’ll help you explore your options and can support you through goal setting, budgeting and personal finance management—all at no cost to you.