Everything You Need to Know About Debt Management Plans

If you're scrambling to manage debt and struggling to make minimum payments, you're in trouble. But it doesn't necessarily mean you're on the road to bankruptcy.

You might be a good candidate for a debt management plan with a credit counseling agency. A debt management plan can be negotiated between the agency and creditors to pay off your debt. It can take three to five years to complete a plan, will cost money to enroll and could negatively affect your credit score in the short term. But in the end, you should be free of credit card debt.

What Is a Debt Management Plan?

A debt management plan, also known as a DMP, is an agreement a nonprofit credit counseling agency reaches with credit card companies to repay your debts on a schedule ranging from about 36 to 60 months. Under such a plan, you pay an agreed-upon amount each month to the agency, which sends payments to your creditors and may negotiate to reduce or waive finance charges or fees.

A counselor will determine if a plan is the right option for you after reviewing your finances at a financial counseling session, which could take place in person or over the phone.

Consumers on DMPs at credit counseling agency Money Management International pay down an average of about $19,000 in debt with a $489 average monthly payment, including program fees, over a period of four years, according to a study by the company.

Your financial counseling session will likely be free, but enrolling in a DMP typically requires a startup fee and monthly fee. You can expect to pay between $30 to $50 to sign up and $20 to $75 per month to use the program.

[Read: Best Credit Cards for Bad Credit.]

How DMPs Are Developed

During a financial counseling session, a counselor will ask for a full accounting of your income, assets and expenses, such as car payments, rent/mortgage and utility bills. Once an action plan is created to pay down the debt, the counselor can suggest a variety of options based on what you can actually afford, says Peter Klipa, senior vice president of creditor relations for the National Foundation for Credit Counseling.

According to NFCC statistics, about half of the people who receive financial counseling are recommended for a DMP, and about half of that group actually enrolls.

A counselor may recommend a DMP if you have a large amount of unsecured debt with two or more creditors but have enough income to make a monthly payment. DMPs can address credit cards, unsecured loans and collection accounts, such as medical debt. The counselor will negotiate terms with the creditors and act as the go-between once a plan is approved; all you need to do is send in your monthly payments.

There's nothing stopping you from trying to negotiate debts with credit card companies on your own. You can save on program fees if you pay creditors directly. But credit counselors are experienced negotiators in this area, and not all consumers are prepared to face debts systematically like a credit counseling agency can.

It's common for people who need a DMP to have experienced "some kind of shock" like a divorce or job loss, Klipa says. "There's something that comes into their lives that changes things."

When Are DMPs Recommended by a Credit Counselor?

Consumers who have enough income to make an acceptable monthly payment to creditors are most likely to get recommended for a DMP. The goal is for the consumer to avoid less pleasant options such as debt settlement or bankruptcy.

A counselor will recommend a DMP in cases of credit card debt problems almost exclusively because other forms of debt -- such as auto loans, student loans and medical bills -- don't have the same arrangements set up between credit counseling agencies and creditors.

"DMPs were set up in response to the growth of credit cards -- use and overuse," says Thomas Nitzsche, communications lead for Money Management International, a network of nonprofit programs that offer consumers free credit counseling and financial education. Other types of debt aren't ideal for a DMP because of legal reasons, regulations or creditors' preference of dealing directly with the customer, Nitzsche says.

This arrangement with counseling agencies and creditors means that negotiations are fairly straightforward, with the goal of helping the customer pay the outstanding debt.

[Read: Best Credit Cards for Fair Credit.]

Can You Get a DMP?

You may not qualify for a DMP if your credit card minimum payments haven't been paid in several months or your monthly income easily allows you to meet the minimum payments.

If you have missed your credit card payments for several months -- which means you have one or more delinquency notations on your credit report -- the terms of the DMP might not be as favorable. Credit card companies are ready to sell your debt to a collection agency if it's been more than 120 days since you paid them.

Though collection accounts can be included in a DMP, Klipa and Nitzsche say plans can be more effective if you enroll before you get to collections.

"It usually ends up being best if it's fairly early in the delinquency process," Klipa says. There are more options available for credit counseling agencies the sooner they can get involved with beleaguered customers.

Nitzsche says, "You can see the impact that could have on someone who is carrying $24,000 on six or seven accounts."

There is no income requirement for a DMP, but it might be difficult if your income is too high or low, Klipa says. For example, if you have a $100,000 salary and the ability to pay current debt payments, creditors may not agree to a DMP, Klipa says.

Credit counselors are looking to get consumers "the best needs-based deal they can afford," Klipa says. "It has to come from a grounding of what does this person really need based on an understanding of a situation."

What to Do When You're on a DMP

If you enroll in a DMP, be sure to live within the budget you set with the credit counseling agency, and try to avoid going back to the pitfalls that might have precipitated your financial crisis.

Other tips:

-- Use credit cards carefully. The credit card accounts involved in the DMP will be shut down, so it's possible you won't have any credit cards to use during your plan. However, if you have other cards with no balance or a low balance, plan to use them for emergencies only -- carefully, Nitzsche says.

-- Make your payments. One missed payment won't necessarily dissolve your DMP, but it's a good idea to stay current.

-- Stay in touch. A successful DMP requires ongoing communication between you and the counseling agency -- and not just about your monthly payment. "We do get some clients who feel like they can just sign up and walk away. Unfortunately, that's not the case," Nitzsche says. Clients have to pay attention to creditors' statements and possibly update the debt balance with the agency because of fees or other costs that weren't accounted for in the original agreement.

-- Accept your new lifestyle. The most successful clients are the "ones who have really decided to make a change in their lives" and are dedicated to succeeding with the plan, Nitzsche says.

Rod Griffin, director of public education at credit bureau Experian, says, "The whole intent is to help you get grounded again financially so you can begin to recover."

The completion rate for DMPs is about 70% to 75%, according to NFCC figures. Some who don't complete the plan might work directly with creditors to pay the debt, Klipa says. Also, some will choose to wipe out the debt with a debt consolidation loan, Nitzsche says.

[Read: Best Secured Credit Cards.]

How a DMP Affects Your Credit Score

In the long run, your credit score should improve if you have successfully completed a DMP.

Your credit score could suffer because of the effect on your utilization rate, which is the difference between your credit limit and the debt you have on the card. If you close a credit card account under a DMP, your credit line will be reduced to the balance you have on the card, which is a 100% credit utilization rate. A credit utilization rate of 30% or less is recommended for a good credit score.

Your score could also take a hit if you agree to a lower monthly payment for one or more credit cards, which will be highlighted on your credit report as a debt that's not being repaid under the original agreement.

However, in the long term, a DMP could preserve your credit score better than alternatives such as letting the accounts go to collections, debt settlement or bankruptcy.

It's important to make sure that the credit card issuers correctly portray your DMP arrangement on credit reports, Griffin says. For example, the account should be listed as current if it's being handled within a DMP and payments have been consistent.

"It would be essential for the account to show a payment status of 'current,'" Griffin says. "If the account is reported as delinquent during the repayment period, it would hurt scores as well. In many cases, accounts are already seriously delinquent when they are entered into the DMP and would continue to show that delinquency if that is the case."

You'll want to check your credit report to make sure a creditor makes correct remarks about your account.

During the DMP, you might find that a creditor "re-ages" your account after you make a few on-time payments. This means that the account would be moved from delinquent to current based on your DMP and consistent payment schedule.

When the DMP is complete, make sure it's considered paid in full instead of settled, which would indicate that you didn't pay the full amount as agreed upon, Griffin says.

Klipa adds, "I don't know of any DMPs that are not paid in full, and therefore question any creditor who would report them as settled. If someone leaves the DMP and resolves with an individual creditor, settlement might be an option outside of the credit counseling disbursement process."

A credit score could go up by 100 points or more after three years on a DMP, according to a 2015 study by Clearpoint, which is a division of Money Management International. Clearpoint kept track of clients on DMPs and found that scores increased from an average of 529 to 635 in the first 36 months, thanks in large part to regular monthly payments. It's also possible the score would go up again once the debt is paid off.

While you're on a DMP you could still attain loans for secured debt, such as a mortgage or an auto loan, but your interest rate might be higher than you'd like if you've had too many recent delinquencies.

DMP Alternatives

If your debt load is overwhelming and your income and assets won't be able to cover a DMP-negotiated monthly payment, you might have to deal with debt settlement or bankruptcy.

There's some confusion between DMPs and debt settlement. With debt settlement, a company -- most likely a for-profit entity -- negotiates with creditors to allow you to pay part of the debt in an effort to resolve all of it. While the settlement company negotiates with the creditor, the company will ask you to send it payments each month that will be held in an account used for the eventual payment.

DMPs are usually handled by nonprofit organizations, while for-profit debt settlement companies offer debt repayment negotiation terms, Griffin says. It's important to understand the difference and what the implications will be for the debt.

Settlement arrangements could be a problem if you're not able to afford the monthly payments; creditors might not be able to settle all your debts; and if you stop paying your creditors -- as settlement companies sometimes recommend -- it could make your account delinquent.

"There isn't a one-size-fits-all for every consumer," Nitzsche says. "It depends upon the status of the debt."