Many of us know that setting financial goals and creating budgets can help us manage our money. However, it’s also important to manage your debt. Most Americans are carrying around at least one credit card, and the average balance on a credit card is just under $5,400 as of 2020.
Debt management is a way to keep up with your bills, especially if they have seemingly gotten out of control. You can use many strategies to manage your debt, including the debt snowball method or working with a credit counseling organization. In any of these cases, you will create a debt management plan that fits in with your specific budget and financial situation
What is debt management?
Debt management is a way to get your debt under control through financial planning and budgeting. The goal of a debt management plan is to use these strategies to help you lower your current debt and move toward eliminating it completely.
You can create a debt management plan for yourself or go through credit counseling to help you with your plan. Both ways have advantages and disadvantages. Setting up a plan yourself is the simplest way forward, but sometimes it can be helpful to have an outside partner providing help or accountability.
How does debt management work?
Debt management plans are meant to address unsecured debts like credit cards and personal loans. Debt management usually happens in one of two ways.
DIY debt management
The first option is a DIY version of debt management. In this version, you create a budget for yourself that will allow you to pay off your debts and maintain your financial stability. The debt snowball or debt avalanche methods are DIY versions of debt management.
You can use budget calculators, repayment calculators and financial management apps to help keep you on track. If need be, you can also do some negotiating with your creditors to try and lower your monthly payments or interest rates to help you decrease your debt. Once you have gotten the debt under control, you can decide if you want to keep or close an account.
Debt management with a credit counselor
The second form of debt management is to go through credit counseling. You can find a credit counselor in your area through the National Foundation of Credit Counselors. There are both nonprofit and for-profit credit counselors. Read reviews and understand any fees that you might be charged before signing up for a credit counselor.
A credit counselor will help you come up with a plan to repay your debt and can negotiate a payment plan with your creditors. This payment plan is meant to help you eliminate your debts. Depending on your circumstances, your credit counselor may close your accounts as each debt is paid off, to avoid creating any new debt.
Is debt management right for you?
Debt management can be a helpful tool for releasing debt, but it isn’t a magic bullet. Debt management does not address secured debts like mortgages. Another important thing to note is that debt management doesn’t stop your bills from coming. For debt management to work, you will need to have enough income to cover your existing bills.
A debt management counselor may be able to negotiate a lower monthly payment or interest rate, but the bills will still have to be paid on a regular basis. And missing a bill is not a great option. Not only will it have a negative impact on your credit score, but it may also cause your creditor to cancel your negotiated repayment plan. This will leave you back at square one with your debt.
Does debt management affect your credit score?
While debt management can be a helpful tool to get debt under control, it can have negative effects on your credit score.
For example, if you are attempting to get a lower interest rate, you may trigger a hard inquiry into your credit report. Hard inquiries stay on your credit report for two years and can impact your credit score for one year.
However, this is a short term effect and can easily be countered by other factors. For example, if you are able to get your rate lowered, and this means you’re able to pay your monthly bill consistently, you’ll see a positive effect on your payment history, which makes up 35 percent of how your credit score is calculated.
While consistent payments will have a positive effect on payment history, missing payments will cause your credit score to lower significantly. If you, or your credit counselor, are using a tactic of withholding payment from your creditor to get a better rate, expect your credit score to go down.
Another key factor in the health of your credit score is your credit utilization. This factor makes up 30 percent of how your score is calculated and is linked to how much debt you carry compared to how much credit you have available. The ideal credit utilization is between 10 and 30 percent. This means that your debt should equal no more than 30 percent of your available credit across all accounts.
Having all of your debt consolidated into one bill can be beneficial for paying things off. However, if you close some of your accounts, you’ll affect your credit mix, which makes up 10 percent of your credit score, and your credit history, which accounts for 15 percent.
Other financing options to handle debt
When thinking about how you will handle your debt, choose an option that works best for your current financial situation. Debt management is one way to handle debt, other options are worth considering.
Balance transfer credit cards
Balance transfer cards can offer you the ability to move your debt to a zero percent introductory interest card. This will give you the option to pay off your debt without having to worry about interest. Balance transfer cards do, however, come with fees, including a fee for each balance transfer in most cases. If you are not moving your balance to a preapproved card, you may have to deal with a hard inquiry into your credit report.
Balance transfer cards are available if your credit score is in the good-to-excellent range, but may not be available if your score is in a lower range. You’ll also need to have a clear plan for repaying your debt before the zero percent interest period ends, because then you’ll be subject to the regular variable APR on any remaining balance.
Personal loans give you the chance to receive a lump sum of money that can pay off your debt all at once. A personal loan is a good option if you know that you will need more time to get your debt under control. Personal loans will offer a repayment period that typically ranges from two to seven years. Unlike a credit card, you will have to repay your personal loan by the end of the specified time period.
Your interest rate for a personal loan will depend on your credit score. Interest rates for personal loans can range from 5 to 36 percent, so make sure that the rate you receive is lower than the rate you are currently paying on your outstanding debt. Bankrate has a tool that can estimate your interest rate for some of the top personal loans on the market.