When you’re trying to get out of debt, you’ll likely come across debt settlement and debt management as two of your options. But while these options sound similar — each is designed for debt relief — they’re very different.
One difference between debt settlement and debt management is who’s handling it. Consumers usually work with a for-profit debt settlement company to come up with a debt settlement plan and typically work with a nonprofit consumer credit counseling agency to come up with a debt management plan.
The #1 Way the Two Differ
Both debt settlement and debt management enable you to achieve debt relief.
However, a debt settlement company negotiates with your creditors to lower the total amount you owe. Meanwhile, a debt management plan negotiates with your creditors to lower the interest rates on your debts, yet you’re still responsible for paying the full amount you owe.
Debt settlement does not require you to pay back every penny of the total amount you owe, while a debt management plan does require you to back the total debt you owe. Both of these alternatives apply to unsecured debt (debt without collateral), such as credit card debt and personal loans.
Think of debt settlement and debt management as cousins rather than twins in the world of debt relief options. They’re related, but they’re not identical.
For-profit debt settlement companies negotiate with creditors to pay less than what you owe. In exchange, these companies typically collect a fee from you of 15% to 25% of the amount of debt being settled.
Before any settlement offers are sent to your creditors, you must make monthly payments into a special savings account. As the company is negotiating with creditors and as you’re accumulating money in the account, you’re usually encouraged to stop making individual payments to those creditors during that period of time. The creditor usually gets the total settlement amount as one lump-sum payment
The debt settlement process often takes 24 to 48 months to finish.
The amount of money you save through debt settlement — the difference between what you originally owed and what you wound up paying — might be taxed by the IRS.
READ MORE: Is debt settlement the cheapest way to get out of debt?
A nonprofit credit counseling agency usually charges a small one-time upfront fee as well as a monthly management fee (up to $79) for enrollees in a debt management plan (DMP). The agency starts with a free credit counseling session, which includes budgeting help. Then, your counselor decides whether you’re a good candidate for a DMP.
If you’re enrolled in a DMP, the agency will work with your creditors and debt collectors on a repayment plan, potentially with lower interest rates than what you’re being charged now.
Generally, you must repay all of the debt you owe during a three- to five-year period.
Unlike debt settlement, debt management typically doesn’t carry any tax implications.
READ MORE: A complete guide to debt relief programs
The Basics of Debt Settlement
A debt settlement program generally involves working with a for-profit company to settle your unsecured debts, such as credit cards and personal loans.
Usually, you stop making all payments on debts owed (which can result in late fees and damage to your credit score), and the debt settlement company handles all communication with your creditors about negotiate a lower amount of money to be repaid. If payoff agreements are reached and you’ve accumulated enough money, cash from the third-party savings account will be distributed to each of your creditors.
The debt settlement process usually lasts 24 to 48 months. Keep in mind that the IRS may consider any unforgiven debts to be taxable income, which then might leave you with a tax bill.
To find a reputable debt settlement company, read online reviews; ask friends, relatives and colleagues for recommendations; and check the Better Business Bureau website.
READ MORE: Here are the best debt settlement companies
The Basics of Debt Management
A debt management plan can help consumers struggling with repayment of unsecured debt, such as credit cards and personal loans. This type of plan usually reduces the interest rates on the debts owed, and can also decrease fees and monthly payments.
After undergoing credit counseling with the agency, you may be placed in a DMP. Through this plan, you make monthly payments to the agency, which then sends regular payments on your behalf to each creditor. Unlike debt settlement, there’s no special savings account.
A DMP lasts three to five years. The amount of debt you owe and the ability to make on-time payments are critical to success with this type of plan, as late payments and late fees can cause a financial setback.
Enrolling in a debt management plan puts an end to phone calls from debt collectors and tends to have a neutral effect on your credit scores.
Your best bet for finding a reputable nonprofit credit counselor is the National Foundation for Credit Counseling (NFCC). Each NFCC counselor is accredited by the Council on Accreditation, a third-party nonprofit accrediting organization.
READ MORE: 5 best ways to get out of credit card debt
Which One Works Best for Me?
Figuring out whether debt settlement or debt management is best for you depends on your circumstances. For instance, how much debt do you owe? How concerned are you about your credit scores? Are you planning a large purchase in the near future? What is your personal finance situation?
If you’re not worried about the negative hit to your credit scores and how that could affect immediate future purchases, then debt settlement may be an ideal option for getting out of debt quicker. But if you want to ease the impact on your credit and can afford to make payments over a three- to five-year period, then debt management may be a more viable option.
READ MORE: Why did my credit score drop?
Do I Really Need Professional Help?
Fortunately, DIY is an option when it comes to debt relief. You’re free to tackle debt settlement negotiations on your own or come up with your own debt management plan, rather than relying on a pro to step in. However, keep in mind that the DIY route to become debt free takes time and patience.
Start by viewing your credit report to see exactly how much you owe, along with the interest rates and the names of creditors. After that, you might consider free guidance from a credit counseling agency before diving into DIY debt settlement or debt management.
For those who learn how to handle their finances, deal with debt collectors and develop their own debt relief plans, DIY debt relief is certainly a good option.
Special Programs for Military Veterans
Several programs can help veterans who are struggling to pay off credit card debt, personal loans and other debts. Organizations like the U.S. Department of Veterans Affairs, Veterans of Foreign Wars (VFW), Operation Family Fund and Operation First Response can lend a hand to veterans who’ve run into a troubled financial situation.
READ MORE: Debt consolidation loans for active duty military service members and Veterans
What Happens Next?
When you take part in a debt settlement or debt management program, your credit scores may take an initial hit. This is especially true if a debt settlement company encourages you to stop making debt payments, which can put a big dent in your all-important payment history. But as creditors are paid off, this positive payment activity should benefit your credit.
Other Debt Relief Options
As your considering debt settlement or debt management, don’t overlook the fact that alternatives are available:
- Debt consolidation lets you roll several debts into a single loan, giving you one monthly debt payment plan to track instead of multiple monthly payments. Another potential benefit: A debt consolidation loan may charge an interest rate that’s lower than the overall interest rate for the debts you’re consolidating, which could lead to a lower monthly payment.
- A balance transfer credit card typically comes with a 0% introductory APR (annual percentage rate) that lasts anywhere from 12 to 21 months. If you’re able to pay off your transferred credit card debt within the 0% window (before the much higher regular APR kicks in), you could save hundreds or even thousands of dollars in interest.
- Bankruptcy should be considered a last-ditch effort to wipe out your debt. A bankruptcy can linger on your credit reports for 10 years if you pursue Chapter 7 bankruptcy (debt elimination) in federal court or seven years if you pursue Chapter 13 (debt repayment).
READ MORE: Debt settlement vs. debt consolidation
The Bottom Line
Neither debt settlement nor debt management should be taken lightly. Consider the effects that both types of debt relief would have on your finances and your life before going with one of these options. Also, be sure to review the alternatives, such as a debt consolidation loan or a balance transfer credit card.
Most creditors participate in debt management plans, but not all of them do.
Mortgage lenders often won’t lend money to homebuyers who’ve recently gone through debt settlement. Plus, it’s probably not wise to take on that much debt right after a debt settlement. However, lenders generally will become less reluctant to approve a mortgage after some time has passed and you’re able to show that you’re responsibly using credit.
It’s possible to settle student loan debt, although it’s easier to do so with private student loans than federal student loans.
You should definitely consider debt consolidation if you’ve got several high-interest loans that you’re trying to pay off. But this may not be an option unless you’ve got decent credit.
Debt settlement with no late payments stays on your credit reports for seven years from the date when the debt was settled. However, you can begin rebuilding your credit right after the debt is settled by making on-time debt payments, wiping out past-due debts and keeping credit use to a minimum.