Debt Management

Elizabeth Johnson

Financial Advisor
Updated: 12/2017

Simply put, debt management refers to the ways in which you can deal with your debt, an entity you are finding difficult to handle on your own with each passing day. It is important to research on and practice a debt management solution that suits you as it can help you get out of the vicious cycle of expenditure, increasing debt, and more expenditure.

Nowadays, it is also possible, and in fact recommended, that you take outside help for the same that is professional and affordable in nature.

There is no one correct way to deal with credit card debt, and the right option for you totally depends on how grave your situation is.

What are the telltale signs that you should start worrying about your debt?

Your debts start to worry you

At first, this does not make much sense. The thing is, you do not have to perform any kind of mathematical calculations before deciding that you have to do something about your debt situation right now. Simply, ask this question: “Do you feel in any way bothered by the debt you currently owe?”  If the answer is yes, then you should do something about it.

One of the biggest mistakes people make nowadays is assumed that because they have not reached that certain point yet (we’ll discuss this later on), it’s okay to open up new credit cards. In the 2008 financial crisis, many people lost their jobs and ended up in the streets. You can never be a hundred percent certain what will happen tomorrow or the next day or year, so if the situation allows it, it is best not to have any debt at all.

You are having a hard time budgeting

If you are still able to make the payments on time but have to give up a lot in exchange, then you should think about why that is the case. Look closely at your monthly budget and see how much you are allocating for debt payments. Only you can decide how much is tolerable because it can vary based on your lifestyle and household size. If it comes up to the point that you have to forgo healthy snacks to make ends meet, you know you have a problem.

Your debt-to-income ratio is 36% or higher.

Getting your debt-to-income ratio is pretty simple. Simply divide your total monthly debt payments (student loans, mortgage, car, etc.) your net monthly income. In truth, it does not say much about your situation, as we have already established in the previous item. For example, after settling your monthly debt payments, you still have $2,000 left. By yourself or with a partner, you can manage to live a decent life with that amount and perhaps still save a little. But if you have five kids, that would be a different story.

The higher your debt-to-income ratio is, the riskier lenders would think lending you money is.

Your savings is too little compared to your debt

Borrowing money is costly, and how much exactly it would cost you is determined by the interest rate. Aside from the opportunity cost of paying your debt instead of saving, consider also the returns of your savings and investments compared to what you pay in interests. Most of the time, the best action is to simply pay off the debt (or allocate a bigger portion to it against saving and investing) so it would not accrue interests over time.

Living is costly and you should have enough to spend when tragedy comes barging in your life. Even if you currently have a good debt-to-income ratio and do not find it hard budgeting, look at your savings.

What are the different ways to manage debt?

Debt Management Program

A debt management program is offered by debt solution companies that asses your financial situation and accordingly suggest a relief program to help you get out of debt in a stipulated time. A suitable debt management program can very well consolidate your debt payments, help you achieve a stable monthly payment schedule, and make you eligible for lower rates of interest. If done right, the program can even help you pay off your entire debt within three to five years.

Debt management programs force you to make tough decisions regarding your finances. For example, it demands that you stop using your credit cards so that you are not misled into thinking that you need things you can’t even pay for. And in order to achieve this, it offers you lower interest rates in return.

In addition, it consolidates your credit card debt and other unsecured debts into a single monthly payment which is made affordable in accordance with your specific financial situation. For someone who is getting a carefully constructed payment schedule customized for a case-by-case scenario, it is not a hard bargain at all.

Now, debt consolidation is exactly what it sounds like. The company you are aligned with will package all your debts together for you and offer you a loan to pay them off at a lower interest rate. Since the firm already has your financial details, it will use one of your assets, like a home or a car, as security. This makes the process of paying debt linear. The amount of money that is saved on interest is used by the company to pay off your credit card debts and get each of their balances to zero.

So you merely have to switch from paying to three to four creditors every month to making a single payment at almost half the interest rate, while the credit counseling agency does the dirty work of negotiating your loans with the bank and paying off your credit card debt.

This also relieves you of the mental pressure of keeping track of all the individual creditors and their respective payments and due dates. The rate of interest that these companies offer to people who avail their debt management program typically ranges from 8% to 12%. It is advised that you pick a non-profit credit counseling agency for the same.

Debt Settlement

Under this, you are allowed to get into a consensual deal with your creditor to ward off a specific percentage of your debt. Now, before you start rejoicing at the aspect of an unprecedented decreased debt, let us educate you on the finer aspects of such a deal. The process of debt settlement involves a lot of risky give and take.

In lieu of the creditors agreeing to take less money than you owe them, some severe penalties will be levied on you. Foremost, such an arrangement will negatively affect your credit score for a long time. The fact that you were so deep in debt that you knew you would not be able to pay it off even in the long run will show on your credit report and may prove to be a hindrance in acquiring loans in the future.

Hence, debt settlement will never be a preferred option for any party, be it the borrower, the lender, or the attorney general tasked with carrying out the deal.

Further, even though a small amount of your debt has been waived off, you are still not exempt from the taxes you owe on the forgiven debt. Along with the tax liabilities, you will have to pay the very high attorney fees through which the debt settlement has been enabled in a speedy manner. The attorney will help you re-route your payments to a fund instead of the creditor.

When the fund reaches a pre-specified level, your attorney will play a crucial role in getting your creditor to agree to settle for that amount. If a formal agreement comes through, your debt will officially be considered settled. Due to this, the attorney fees for debt settlements usually range around 10%-20% of the total amount settled.

How to enroll in a debt management plan?

Even though debt management programs are customized to suit your particular needs, not everyone can instantly avail one. Since the matter concerns you incapability to pay off existing debts, you have to be eligible to be able to make use of these services so that the company can retain only serious clients and weed out any unwanted elements. However, it is not as difficult as it sounds.

The most basic step to qualify for a debt management program is to indulge in a credit counseling session with a certified counselor from the debt solution company you choose. This can be easily achieved as companies nowadays offer telephonic and online counseling, along with the traditional in-person approach.

A counseling session is of utmost significance in order to understand your problem. It helps a certified professional gauge the extent of your debt, based on which he recommends different debt management programs to you that have different terms and conditions. In the session, first, the root cause of your debt will be identified. Next, a household budget will be created for you, with your help, of course, that will establish an upper limit for your standard upcoming expenses. Once that is out of the way, the counselor will discuss your credit report with you and chart out all the monthly payments you need to make to pay off your debts.

Taking into consideration all these factors, he will suggest a solution and try to make amends to it to get you on board. This is done so that you feel extremely comfortable with the payment plans that will be set and are fully aware of what you are signing up for. Usually, clients seeking professional advice agree with the recommendations and instantly enroll in the debt management program they have qualified for.

All of this should not take less than 30 minutes or more than 60 minutes of your time. And you also need not worry about how stringent these plans can be. On request, you can be given one credit card that you will only be allowed to use in emergencies. In short, the program does not aim to make your life uncomfortable or less luxurious but to help you reign in unnecessary expenses, all the while keeping you in the loop.

Does bankruptcy come under debt management?

While bankruptcy is certainly a form of debt management, it is essentially the last resort to ward off debts. This happens in cases where debts are so high that it is impossible for the person to pay them off. Under this, you will have to liquidate all of your assets in an attempt to settle your debt, which will legally leave you bankrupt. Other than losing your property, this can severely affect your credit score by as much as 200 points.

Furthermore, bankruptcy will go on your credit report for a minimum of seven to 10 years. Another way of settling debt under bankruptcy, which is equally damaging, is to ask your creditors to eliminate your debt by agreeing to a repayment plan over a time period of three to five years.

On the other hand, a debt management program is not a legal proceeding similar to the abovementioned processes. While it does show on your credit report, it has no substantial impact to that end. In fact, by the end of it, you can see a sure shot increase in your credit score.

To make sure you get to avail the best debt management program in a personalized manner, choose a credit counseling company that is accredited by the National Foundation of Credit Counseling and is a non-profit. This will also ensure that you get charged with a low fee for their services and are provided with impartial financial advice.

Along with equal installment plans, the counselors will also share strategies to save more money in your day-to-day life with you, without compromising on household needs. In case, your financial situation changes in the middle of the program, you can also approach your counselor for a review of your modified requirements.