Sometimes people who have accumulated debts from a range of creditors, and feel "over their heads" in keeping track of their debts and paying their bills, will consider using a debt management service, usually through a credit counselor.
Before you sign up with a debt management service, you should make sure that you will be comfortable with the service, and that the service you use will act in your financial best interests.
A debt management service acts as a middleman between you and your creditors.
- The service obtains a single monthly payment from you,
- Your monthly payment is used by the service to pay off various debts on your behalf.
- The service receives a commission, usually a percentage of your monthly payment, and possibly additional rebates from your creditors.
Debt management companies may be willing to make payments on all of your debts, but most often their management services are for unsecured debts, such as debt from credit cards, as opposed to secured debts such as car loans and home mortgages.
Debt Management vs. Credit Counseling
Debt management, of itself, is not the same as credit counseling, which is typically more of an advisory and educational service. Debt management is also not suitable for every person who is in financial distress. People whose debt is primarily secured will usually get little benefit from debt management.
Debt Management vs. Debt Consolidation
A different type of service will provide a debt consolidation loan to pay off some or all of your existing debt, and replace it with a single loan and a single payment. Ordinarily, once the consolidation loan is issued the consolidation service takes no further action on your behalf, and you are solely responsible to make payments on your loan.
If your debt management service negotiates reduced interest rates or balance reductions on your behalf, those negotiations will likely be reflected on your credit record. Thus, some (but not all) creditors may treat you as a higher risk when issuing future credit.
However, the effect on your credit is ordinarily far less significant than that of a continuing pattern of late and missed payments. Also, if you forego debt management and end up having to file for bankruptcy, all creditors will view you as a higher credit risk.
It is not unusual for a debt management service to obtain a commission of 10% or more on your monthly payment. It is possible also that the consolidator will be able to obtain a rebate from your lenders on the amount of each monthly payment they make on your behalf, resulting in an even greater commission.
The chance for significant, easy profits can inspire unethical debt management services to encourage people to sign up for services that are not in their best financial interest.
Given that many people have difficulty sticking with a debt management program, or encounter sudden financial emergencies during the course of a debt repayment plan, it makes sense to ask up front what will happen if you miss a payment, are late with a payment, or may not be able to make your full contribution.
You should know the debt management company's policies before you run into a problem, so that you are not surprised when you are facing new, significant financial difficulties.
When private debt management services started to emerge in large numbers, people were frequently advised to obtain help only from nonprofit debt management services. The idea was that the for profit services would often seek to obtain excessive commissions, while nonprofit services were performing a public service.
Status as a nonprofit does not of itself mean that the service has your best interest at heart. There is an enormous difference between being nonprofit and being a charitable organization. Many profiteering debt consolidation services operate (or claim to operate) as nonprofit companies.
Just because an organization declares itself to be nonprofit doesn't mean that it is necessarily either better or cheaper than a for profit service.
Whether the debt management service you are investigating is for-profit or non-profit, play it safe by using credit counseling and debt management services accredited through the Financial Counseling Association of America or the National Foundation for Credit Counseling. It is far less likely that an accredited organization will charge excessive fees or try to take advantage of you, than it is for an organization that is not accredited.
Before you sign on for a debt consolidation loan, consider your alternatives:
Negotiate With Your Creditors
Sometimes all you have to do is contact a creditor and ask for a break. That is, if you simply call them up and ask some creditors will offer you a lower interest rate, or will waive certain fees associated with your accounts. This is most often true of credit card companies.
You may be better served by seeking a debt consolidation loan. If you qualify for a debt consolidation loan, compare the payments you would have to make under the loan to the amount that a debt management service will charge to pay down your debts. Choose the option that is in your financial best interest.
Using a Traditional Lender
You may also be better served by using a traditional lender, as opposed to a debt consolidation service.
Unsecured Loans: If your credit is relatively good and you are employed, you may be able to obtain an unsecured personal loan that you can use to pay off some of your higher interest debt, such as your credit card debt.
Secured Loans: As many debt consolidation services will use your home as collateral, you may well be best served by refinancing your home or obtaining a home equity loan, and using the proceeds to pay off your debts.
There is a possibility that your best option is to declare bankruptcy. If all consolidation will do is forestall an inevitable bankruptcy, consider whether you will be better served by proceeding directly to bankruptcy.
If you made a timely monthly payment to your debt management service, but it nonetheless was late with or failed to make one or more of your payments to your creditors, you should find out why. If the service is careless with paying your debts on time, it may be hurting your credit.
If the service is charging you additional fees you didn't understand, and is applying part of your monthly payment to those fees instead of paying your creditor, you may want to discontinue the service.