From monthly payments to one-time lump-sum payoffs, the options of debt management plans and debt settlement can be complicated.
Impacts on your credit and your tax bill can loom. There are credit-counseling organizations and attorneys who are legitimately trying to help people in debt -- but then there are also those who will charge too much for the service or do too little for what you pay in fees.
If you choose carefully, however, and learn to mind the fine print, these programs can be helpful tools for getting free of what you owe. Let's look at how debt settlement and debt management plans work -- and how they can work for you.
Debt management plans and debt settlements are two different things. Each approach applies differently, depending on the goals you're trying to achieve.
Debt management plan
By negotiating new, lower monthly payments -- meaning that creditors waive fees and cut interest in exchange for the guarantee of payoff -- you zero out your balances over a set period of time (typically four to five years). A debt management plan usually only appears on your report as a status note on the affected accounts, and then only if one examines a full report. But if your creditor closes the account at the end of the plan, that will show up more plainly. Debt management programs are often set up with the help of a credit counselor or an attorney, and this almost always involves fees.
This is a negotiated lump-sum payoff of less than the full balance. Again, a fee-based counselor or attorney is often involved, especially in the negotiation phase. Debt settlement has a greater impact on your credit report: The discharged part of the debt is logged. Also, you'll incur a tax liability, as the IRS views the amount forgiven as income.
Note that many states have laws about what a debt settlement or a debt management service can charge for its work. It's often in the neighborhood of 10% to 15% of the amount saved and/or $50 for "education" fees and the like. States that do regulate credit counseling and debt services usually post their rules online -- you can find a directory to statutes at the National Conference of State Legislatures.
Tips for picking and negotiating your plan
It's time to dig into the steps that will help you complete your debt management plan and debt settlement successfully. Keep the following key strategies in mind.
Perform your due diligence. Talk to more than one agency or firm and compare. Ask for references from previous clients. Check organizations' histories with your state's attorney general and also with your Better Business Bureau. You can refer to a list of approved counselors at the National Foundation for Credit Counseling.
Get everything in writing. You want to see the important questions answered in your paperwork. For example, in a settlement situation, what's the estimated time frame for negotiations? Where is your money being held in escrow during that period? Never take these kinds of details for granted.
Don't rush to an agreement. Don't be too eager to accept first offers in settlement negotiations. They're almost certainly not the best number you're going to see, and it may take two or three passes to get the amount to where you want it.
Have the cash in advance. When it's known that there's cash ready at hand, many creditors will negotiate to a number close to what they understand they can get right away, rather than holding out for a promise of money to come.
No new credit purchases. The accounts your plan covers will be off limits for any further spending. In almost all cases, applying for new lines of credit during the term of the payoff will be out of bounds, too.
Never miss a payment. It's crucial to consider the amount you're set to pay against a realistic estimate of your cash flow in the months and years ahead. Miss a payment, or fail to have the cash on hand when it's time to make the transfer in a settlement, and your plan is often void without a second chance.
The underlying principle: Proceed with caution and in a measured way, and you'll watch your personal finances grow stronger for the future. When you pick a well-constructed plan, the reasonable charges and fees end up being worth their weight -- not in gold, but in the freedom you'll feel when your settlement or management is done.
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James O'Brien is a contributor to WiserAdvisor.