September 27, 2022

Debt Management

Debt management is any system used to pay off debt and regain control of your finances. It can also refer to credit counseling services.

The term debt management often refers to debt management programs offered by credit counseling organizations that help borrowers approach their debt in a more manageable way. Whether you DIY your debt management plan or hire a credit counseling organization, debt management requires having a set plan in place to become debt-free in the future.

How Does Debt Management Work?

Debt management can take several different forms. While some borrowers turn to a debt management program to help them tackle their debt, there are alternatives to consider, including taking a DIY approach.

DIY Debt Management

The first strategy you can use to manage your debt is DIY debt management. With this option, rather than working with a professional, you take a DIY approach to tackling your debt. DIY debt management is the most common option that people choose and is appropriate for most people.

The two primary methods of DIY debt management are the debt snowball and the debt avalanche. When using a debt snowball, you make the minimum monthly payment on each of your debts except for the smallest one. Any extra money in your budget should go toward your smallest debt. Once that debt has been paid off, you reallocate all the money you were putting toward your smallest debt to your next smallest debt, creating a snowball effect.

The benefit of the debt snowball is that it provides quick, emotional wins. When you’re able to pay off your first debt, it can provide the motivation boost you need to keep going.

When you’re using the debt avalanche, rather than prioritizing your smallest debt, you prioritize the one with the highest interest rate. You make the minimum monthly payment on all of your debts, with all extra money in your budget going toward the debt with the highest interest rate. Once that debt has been paid off, you move onto the debt with the next highest rate.

The benefit of using the debt avalanche is that in the long run, you save the most money on interest. With the debt snowball, the smallest debt isn’t necessarily the most expensive one. It could result in you paying off the lowest-interest debts first, which would cost you the most in interest in the long run. But with the debt avalanche, you’re always saving the most money.

While the debt avalanche is the most cost-effective DIY debt management plan, it isn’t the right one for everyone. Anyone who struggles to stick to a financial plan and needs the motivation that quick wins provide may do better with the debt snowball.

Debt Management Programs

Rather than taking a DIY approach to debt management, you could enroll in a debt management program. With this type of program, the debt management company you hire works with your creditors to reduce the monthly payment and interest rates on your debts. They may also be able to waive or reduce any penalties you’ve accrued.

The goal of a debt management program is usually to agree on a payment schedule that allows you to pay off your debt in a certain number of years.

When you work with a debt management program, you often make your monthly payments directly to the program rather than your creditors. Then, the program — often a credit counseling organization — makes payments on your debt based on the payment plans they’ve agreed on with your creditors.

A debt management program may be most appropriate for someone whose monthly debts have become unaffordable. The credit counseling organization works to make your new monthly payment fit within your budget. Keep in mind that most debt management programs require a fee to get started, as well as an ongoing monthly fee.

Debt Management Alternatives

A debt management program isn’t right for everyone, yet you may have tried the DIY route and found that it doesn’t work for you either. In that case, there are some alternatives available to help you manage your debt.

Debt consolidation loan: A debt consolidation loan is a personal loan that you borrow for the purpose of paying off other monthly debts. The benefit of this type of loan is that it allows you to consolidate multiple monthly payments and interest rates into a single monthly payment with one interest rate. While personal loans often have relatively high interest rates — especially for borrowers with bad credit — they’re often used to pay off credit card debt with even higher interest rates.

Balance transfer: If you have credit card debt you’re working to pay off but find most of your money is going toward interest, then a balance transfer might be a good option. With a balance transfer, you transfer the balance of one credit card to a different card, usually one with a low introductory interest rate. Many balance transfer cards offer introductory rates of 0% for one year or more, allowing your entire monthly payment to go toward the principal. Be sure to read the fine print because the introductory rate could just be deferred interest and to avoid the interest charge, you may need to pay off the card by the end of the promotional period. A balance transfer is often the cheapest way to manage debt, it’s generally only available to borrowers with fairly low balances and good credit.

Debt settlement: Debt settlement is the process of negotiating with a creditor, who agrees to accept less than the amount you owe. Borrowers often use debt settlement with collections accounts they can’t pay off in full but can pay in part. Like debt management, debt settlement is often done through a third-party company that negotiates with creditors on your behalf. Unfortunately, debt settlement can be expensive and often has a significant and negative impact on your credit, especially because debt settlement companies often encourage you to stop your monthly payments while they settle the accounts. There’s also a chance that your creditors won’t agree to a settlement, in which case you’ll have ruined your credit and paid a debt settlement company for nothing.

Bankruptcy: If your debt has become truly overwhelming, you may turn to bankruptcy as a last resort. With Chapter 7 bankruptcy, many of your unsecured debts like credit cards, personal loans, and medical bills can be wiped out. Because of the effect bankruptcy has on your credit — and the fact that it stays on your credit report for 10 years — it’s best used only when you have no other options. It’s also not appropriate for all types of debt, such as secured debts, back taxes, federal student loans, and more.

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