When business owners have bills they can’t keep up with, they often look for debt relief options, and two names that get mentioned over and over again are debt management and debt settlement. They sound similar, but there’s a world of difference. Put simply, debt management programs focus on the mechanics of how you will pay your debts, and debt settlement programs focus on the amount you will pay.
Formal Repayment Program
A debt management plan (DMP) is when you enroll in a formal repayment program through a non-profit credit counseling agency. The agency negotiates with your creditors to lower interest rates and waive fees. In return, you make one monthly payment to the agency, which then distributes the funds to your creditors. You continue to pay back your full debt balance over a set period of time, usually three to five years. This can be a good choice if you have the money to cover your payments but simply can’t keep up with the current interest rates and fees. The goal here is to get out of debt by paying off every dollar you owe. Some people also have to “close their credit cards” as part of the plan. Because of that, your credit score may take a hit in the beginning of the program. Once you are able to repay the debts in full, your credit score should improve.
The case for a debt management plan is easy to make. You get one monthly payment instead of several, the agency works to lower your interest rates and fees, and that one payment helps you create a budget you can actually stick to. The trade-off is that the principal does not shrink. With debt management, you will continue to repay 100% of your debt - over time. That takes a steady income.
Settle Your Debts for Less than What You Owe
Debt settlement is a process where you stop making payments to your creditors and start depositing money into a dedicated trust account. A third-party debt settlement company collects that money. Once enough funds are in the account, usually about half of what you owe, the company negotiates with your creditors to settle your debts for less than what you owe. Remember, not every creditor will agree to a settlement, and no creditor is obligated to accept one. If it takes awhile to build up this amount your credit will likely be damaged with missed payments, possible collections, and possibly lawsuits.
None of this is easy to sit through. Settlement usually means months of harassment by collection agencies. Then there are the costs. Some settlement companies charge up to 25 percent of the amount the creditor agrees to forgive. That fee is paid to the settlement company and sometimes to your bank to establish the trust account. (If you are offered a loan to expedite the settlement process, it may also carry interest fees.) On top of that, the forgiven portion of the debt is considered “income,” so you may have to pay taxes on it.
How long does each one take? DMPs take anywhere between three and five years. Debt settlement can take two to four years. During those years of settlement, your credit score will likely be very low. And settling tends to be a bigger blemish on your credit than a debt management plan. A debtor with a low FICO score might still lose another 60 to 75 points. For someone with a higher FICO, it could be a loss of around 125 points. By contrast, DMPs can raise the score, while settlements, by their very nature, will damage it.
So which one fits your situation? Generally, a debt management plan works best for someone who can repay the entirety of his or her debt in full and hopes to alleviate the interest rate and fees while creating a budget he or she can follow. DMPs are typically for credit cards, personal loans, and lines of credit or medical bills, and they cannot be used for mortgages, car payments, student loans or other secured loans. Debt settlement has its role, but you shouldn’t look to it first. It is typically a last resort for overwhelming debt. Put more bluntly, if there’s no way you’re going to be able to keep up with payments, settling for a better, smaller final payment is a more realistic option. Even then, it is still very risky.
There is also a middle path worth knowing about. Money Management International, a non-profit credit counseling agency, has launched a non-profit version of settlement. The agency’s counselors negotiate the settlement agreement in advance with your creditors, and then remit payments each month to the creditor on your behalf to help you avoid legal trouble. If you are already in a settlement plan and wondering whether you can switch to a debt management plan, a certified non-profit credit counselor can tell you.
Since we’re a business debt settlement company, let’s be straight about that. We specialize in merchant cash advance debt (including stacked MCA debt), and our senior advisors negotiate with funders and lenders on our clients’ behalf for less than the full balance owed. We never sell another loan. Even so, we at Delancey Street do not believe debt settlement should be a first choice. Our advice to you, if you can pay, is you should pay.
If you can’t pay, and you are considering settlement, talk to someone who’ll be honest first. The first consultation is free and confidential. We’ll tell you on the first call if a case is not winnable, or if there’s a cheaper solution. If bankruptcy is the right answer, we’ll refer you to a bankruptcy lawyer. When it comes to a serious debt crisis, any kind of guidance is a start.
