Most Americans carry around at least one credit card, and the average balance on a credit card is just under $5,589 as of 2022.
Although credit cards make purchases easy using borrowed credit, managing your debt and making timely payments isn’t always as easy. If you’re struggling with mounting unsecured debt, 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 your 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.
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 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.
Who this is best for: If you struggle with overspending but can afford to make monthly debt payments by being more disciplined, this approach could work for you.
Biggest advantages: You can protect your credit rating by making timely monthly payments and paying in full. There’s also the opportunity to create a realistic plan that includes milestones and a debt-payoff date to keep you motivated during the repayment journey.
Biggest disadvantages: You won’t have insight from a professional who may have more effective strategies in mind to get out of debt faster. Furthermore, creditors may not be open to negotiations.
You can use budget calculators, repayment calculators and financial management apps to help keep you on track. If need be, you can negotiate with your creditors to try and lower your monthly payments or interest rates to help you decrease your debt. Once the debt is 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 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 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 balances and can negotiate a debt management plan (DMP) with your creditors if necessary. It usually spans three to five years and includes concessions, like a lower interest rate, reduced monthly payment or fee waivers, to help you get out of debt faster. Depending on your circumstances, the creditor may close your accounts as each debt is paid off to avoid creating any new debt.
Who this is best for: People who want professional help managing their finances and credit score.
Biggest advantages: A DMP is generally more cost-efficient to get out of debt than paying creditors directly. You’ll get a set monthly payment and debt-payoff timeline if negotiations are successful. The collection calls will stop. Plus, the impact on your credit score won’t be as significant as it would if you settled the balances for less than you owe.
Biggest disadvantages: You may not have access to your credit accounts for the duration of the DMP. Plus, you’ll relinquish control of your debts to the counseling agency. A single monthly payment, which may include a monthly fee, is made to the agency each month and distributed to your creditors.
Debt relief company
You also have the option to hire a debt relief company to help resolve your outstanding unsecured debts. These for-profit entities negotiate with creditors and lenders to reach settlement deals for less than what’s owed on the outstanding balance.
When you sign up, you will make monthly payments to the debt relief company held in an account. In the meantime, many debt relief companies will advise you to halt payments to creditors and lenders to speed up the negotiation process.
When a settlement is reached, it’ll be presented to you. If you agree, funds from the account you’ve been paying into will be used to make the payment. The debt relief company will also collect a settlement fee from the same account.
Who this is best for: Debt relief could be ideal for Individuals drowning in unsecured debt who’ve tried settling on their own without much luck or would prefer not to file bankruptcy.
Biggest advantages: You could lower the amount you pay monthly towards debt obligations. You may get out of debt faster and keep more money in your pocket, assuming settlement offers are reached.
Biggest disadvantages: Creditors and lenders aren’t obligated to accept settlement offers, which could land you in court, and your credit score will likely be damaged by settling your debts. Plus, you could owe federal income tax if the amount forgiven is over $600.
Does debt management affect your credit score?
While debt management can be a helpful tool to get debt under control, it can negatively affect your credit score.
A hard inquiry may happen at some points in debt management. For example, if you attempt 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 can 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 positively affect 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 your calculated score and is linked to how much debt you carry compared to your available credit. 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 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 the best option 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 a hard inquiry on 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 a clear plan for repaying your debt before the zero percent interest period ends. You’ll then be subject to the regular variable APR on any remaining balance.
Personal loans allow you to receive a lump sum of money to pay off your debt all at once. A personal loan is a good option if you know 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 loan by the end of the specified 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.
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. However, it might be an option to explore if you:
- Have multiple high-interest, unsecured debt like credit cards.
- You’re nearing or at the maximum credit limit for each account.
- Have reliable income to make your payments.
- Don’t anticipate needing to open a new credit account during your DMP.
- Prefer that an agency or company negotiate your DMP rather than DIYing it.
- Have addressed risky financial habits, like overspending.
It can be overwhelming to manage debt, and finding a solution to get rid of it is often even more challenging. Fortunately, debt management options, like the debt snowball, debt avalanche, DMPs and debt settlement, can help you get the relief you need and deserve.
They’re not all created equal, though, as some strategies have more long-lasting adverse effects than others. You may also find another financing option, like a balance transfer credit card or personal loan is more suitable. Weigh the benefits and drawbacks of each debt management method to make an informed decision that helps you meet your debt-payoff goal in record time and works best for your financial situation.