Debt Consolidation vs. Debt Management

Debt Consolidation vs Debt Management Man BudgetingNearly half (48%) of the 179 million adults in the United States who own a credit card, carry a balance forward every month, according to a 2016 survey by the Financial Industry Regulatory Authority and 32% of card owners make only the minimum monthly payment due.

Add the fact that households carrying a balance from month-to-month typically pay 20-36% interest rates on credit cards and owe an average of $16,048 and it’s not hard to figure why millions of American consumers are a missed payment or two away from a financial crisis.

If you have to pay 25% interest on a credit card balance of $16,048, your interest payment alone for one month would be $330!

Where do you turn for help when your credit card debt – or any other form of unsecured debt – gets that far out of hand?

The best option is debt management through a nonprofit credit counseling agency, but that is hardly the only choice. Debt consolidation loans, debt settlement and even bankruptcy, if the financial problem has gotten completely out of control, are other options.

Average Debt Statistics In America

Each state has its own issues with citizens’ debt. Some states have lower average credit scores, and others have higher mortgage debt. See how your state measures up:

Choosing a Debt Relief Option

There are several options for credit card debt relief, but the choice often comes down to debt management vs debt consolidation. Both are practical and proven ways to get out from under the burden of too much debt, though they rely on very different methods. The one similarity between the two programs is that each requires the consumer to make a monthly payment, but that is where the similarities end.

Debt Management Plan

Definition: A debt management program (DMP) is a plan to eliminate debt with the help of a credit counseling agency. You make a monthly payment to the credit counseling agency, who uses the money to make payments to each of your creditors in an agreed upon schedule.

Pros

  • Credit counseling agencieswork with creditors to lower interest rates and relax fees
  • Credit counselors educate the consumer to prevent future financial troubles
  • A DMP is not a loan. The consumer is able to consolidate debts without opening another line of credit
  • You can cancel your commitment at anytime
  • You use your own money to pay what you owe

Cons

  • If you miss a payment, the agreement the credit counseling agency made with your creditors to reduce interest rates and eliminate fees, could be voided
  • You are required to close all but one of your credit card accounts and use that in emergency purposes only

Interest rates: Credit scores are not a factor in Debt management programs. In fact, the average credit score for DMP clients is around 555. Instead, credit counseling agencies work with creditors to set interest rates based on the consumer’s ability to pay. The range could be as low as zero-to-6% for hardship cases (credit scores 550 or below) to an average of 8% for most clients of a debt management program.

Fees:  DMP’s have a $75 set up fee and monthly fees of $30-$55, based on a percentage of your payment. Learn more about debt management program fees.

Effects on credit: The debt management program asks you to stop using all but one credit card. Reducing your available credit (by closing the cards on the program) can negatively impact your score. However, if you stop using the cards and start paying down the balance, your score eventually improves.

Debt Consolidation Loan

Definition: Debt consolidation involves taking out one large loan and using the money to pay off several unsecured loans, like those that result from using multiple credit cards. The lender is typically a bank, credit union or online loan company and the expected payoff time is 2-5 years.

Pros

  • You’ll have the necessary funds to pay off all your creditors
  • The interest rate on the consolidation loan should be lower than your current rates on credit cards
  • It consolidates your debt into one payment, although, if the credit lines remain open and active, the problems may continue

Cons

  • You have to pay creditors and manage your debt on your own
  • Failure to make on-time payments will result in late fees and possibly default

Interest rates: Banks, credit unions and online lenders rely heavily on credit scores when making debt consolidation loans. Any score above 650 could get you a $15,000 loan for 8%, maybe better. The same loan with a score under 650 and the rate jumps into double digits, if you are able to get one at all. Credit scores below 580, for example, are seldom even considered for a loan.

Fees: Debt consolidation loans have origination fees ($75); late fees ($15); insufficient funds fee ($15) and even check processing fees ($7)

Effects on credit: The debt consolidation loan means adding another line of credit, which has a negative impact. However, if you make on-time payments for at least six months, it eventually improves your payment history, credit utilization and credit mix, which will end up being a positive for your credit score.

Requirements:

  • Proof of income: lenders want to make sure you are financially stable enough to take on the loan
  • Credit history: lenders will look at your payment history, and use your credit score to determine your interest rate
  • Equity: for larger loans, lenders may want collateral like home equity to protect them from financial risk

Don’t Forget About Financial Education

The last big difference between debt management programs and debt consolidation loans is the financial education aspect:

Nonprofit credit counseling agencies are required to provide teaching tools that help clients avoid debt problems in the future. They make them available online, in newsletters, through educational books and with other tools that help consumers identify the things that cause financial problems as well as solutions they can use to avoid those troubles in the future.

Lending institutions are not required to teach consumers good financial habits, but most have websites that do contain educational material useful in learning to avoid debt.

So if you are one of those people who can’t resist the buying clout of a credit card and struggle to meet the obligations that arrive 30 days later in the form of a monthly credit card bill, do some research on debt management programs and debt consolidation companies.

Find out if you are comfortable with the cost and time frame involved and work your way back to financial health.

Alternative Ways to Get out of Debt

In situations when you might have a lot of unsecured debt other than credit cards (such as medical bills and personal loans) debt settlement or bankruptcy is an alternative.

Debt settlement is usually done through a debt settlement company, though you could attempt to do it yourself.

Debt settlement companies attempt to get your creditors to accept less than the full amount you owe by offering a lump sum of cash. The way is works is that you stop paying your creditors, and instead pay the debt settlement company each month. When the debt settlement company thinks that they have enough cash to negotiate, they go to each of your creditors and try to make a deal.

It doesn’t always work out, and of course there is a fee. The debt settlement company will either charge you a percentage of your total debt, or a percentage on the amount eliminated through settlement.

Filing for chapter 7 bankruptcy sometimes is a better alternative to debt settlement. In chapter 7 bankruptcy, debts are discharged, while assets, that are not protected, are sold off. You should hire a bankruptcy attorney to handle the proceedings.


Sources:

Lin, J., Bumcrot, C., Ulicny, T., Lusard, A., Motttola, G., Kieffer, C., Walsh, G. (ND). Financial Capability in the United States 2016. Retrieved from http://www.usfinancialcapability.org/downloads/NFCS_2015_Report_Natl_Findings.pdf

NA, ND. Coping with Debt. Retrieved from https://www.consumer.ftc.gov/articles/0150-coping-debt

NA, ND. What’s the difference between a credit counselor and a debt settlement company? Retrieved from http://www.consumerfinance.gov/askcfpb/1449/whats-difference-between-credit-counselor-and-debt-settlement-company.html

Konsko, L. (2014, July 18) Will Consolidating My Credit Card Debt Help My Credit Score? Retrieved from https://www.nerdwallet.com/blog/credit-cards/consolidating-credit-card-debt-credit-score/

Ben. (2012, May 16) Debt Consolidation Fees and Costs. Retrieved from http://blog.readyforzero.com/debt-consolidation-fees-costs/#.V5fHuPkrIdU

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