Debt management plan trumps bankruptcy

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Dear Debt Adviser,
I would like to know if I (should) participate in a debt management program or file for bankruptcy if I have credit-card debtor problems, such as difficulty paying my statement, and not because of job loss. I know both can affect the credit score and credit report. Which — DMP or bankruptcy — is better? If you were me, which would you rather choose?
— Brenda

Dear Brenda,
You can weigh the options of entering into a debt management plan or filing for bankruptcy in different ways. Your concern is with credit scores, so let’s start there.

Before I begin, let me define a debt management plan, or DMP, for my readers who may not be familiar with the term. A DMP is a structured workout proposal that is agreed to by your creditors with the assistance of a credit counselor. The DMP is paid with money left over after developing a budget that accounts for all your actual expenses and fits within your income. The disposable income is reallocated to creditors, with a credit counseling agency acting as an intermediary. This ensures civil communications going both ways. It also takes pressure off the debtor and allows lenders to offer concessions, knowing they will be making a difference as a part of a plan, and not just responding with good intentions.

Accounts that are incorporated into a DMP may include a descriptive notation on your credit report that reflects that action. The fact the account is part of a DMP is not calculated in your FICO credit score. So the sole fact that the account is part of a DMP does not damage your score.

What could damage your credit score is if the lender still marks the account as late. This may happen if the lender is unable or unwilling to change the agreed upon payment in their billing and reporting systems. For example, some creditor systems will not accept a zero percent interest rate, so they continue to calculate interest on the original rate until the debt principal is paid off, then manually go in and record a zero balance. 

Also, if the credit counseling agency that is dispersing payments to your credit card accounts makes a payment late, that would be reflected on your credit report and in your score. Reputable agencies keep up with payment due dates, and you should not have any late payment problems with them. FICO, the company that invented the credit score, has a video on the topic.

A bankruptcy, either Chapter 7 or Chapter 13, is a big negative on your credit report and will have a large negative impact on your credit score because your lenders are either being paid nothing or less than they agreed, whereas a DMP repays the entire balance with voluntary concessions from the lender. A Chapter 7 filing remains on your report for 10 years from the date of filing, and a Chapter 13 remains on your report for seven years. A DMP notation is removed as soon as you exit the plan.

Brenda, my recommendation is to contact a reputable credit counseling agency that you are comfortable with and speak with a counselor. Counseling from the best agencies is always free and confidential. You can explore the benefits of both a DMP and bankruptcy with the counselor and then make an informed decision. Since bankruptcy is a legal process, I’d also suggest you consult with a qualified bankruptcy attorney once you and the counselor have worked out a budget, and you know where you stand. 

On the positive side, another thing that could come from your counseling session is that things are not quite as grim as you believe and you will need neither a DMP or a bankruptcy, just some guidance on how to better manage your finances.

Good luck!

Read more columns by the Debt Adviser.