Debt Management Programs versus Debt Consolidation Loans

A debt management program, or
a debt consolidation loan?

Is it better to take out a loan and repay, or attempt to renegotiate my debt?

A debt management program and a debt consolidation loan are two very separate things. What they have in common is a clear path to resolving your unmanageable debt problem. How they go about it has implications for your future credit ratings and financial self-management. We will explore how both work, so you can choose the best path forward.

The Basic Difference between a Debt Management Program (DMP) and a Debt Consolidation Loan

It's there in the words: loan. A debt consolidation loan is just that, and carries with it all the obligations and pitfalls of any other loan. Instead of paying five different credit cards, you make your monthly payments to one financial institution. However, there are still late fees and penalties if you miss a payment, and the potential for negative impact on your credit score.

The advantages are the lower interest rates – sometimes more than 10 percentage points lower than credit card rates – and the simplicity of paying one creditor. A debt management program runs differently.

A Debt Management Program Is Not a Loan

DMP's, as they are known, involve a credit counseling agency as an active participant. Their job is to negotiate better terms with your multiple credit card companies, lower the rates and modify the monthly payments. They will then close those credit cards, and manage your payments thereafter. You will pay one monthly payment to your credit counseling agency, and they will take care of the credit card companies in turn.

This legally obligates the credit card companies to cease and desist from harassing you for payments. The credit counseling agency is now the address for all communication, and you are out of the picture.

How Do Each of These Affect My Credit Score?

As a general rule, debt consolidation loans help credit score, while debt management programs may cause a slight decrease in your score. Why so?

With a debt consolidation loan, you have basically paid back the entire balance on your credit cards in one shot. Credit reporting agencies see that is a sign of financial health, and raise your credit score accordingly. It is critical to make sure you meet your monthly payments to the bank, because a consolidation loan is a still a loan, and that affects your credit score.

A debt management plan involves you closing all of your credit cards while your credit counseling agency repays. The credit reporting agencies see that your overall credit has been reduced (because you closed all those accounts) and can reduce your credit score somewhat. This, however, is only a short-term issue, provided you finish the debt management program responsibly. These programs generally take between 3 to 5 years to resolve your debt.

What about the Costs?

Each option has costs. With a DMP, you will pay a low monthly fee to the credit counseling agency for managing your debt. The fee is based on a percentage of the total debt. There may also be a setup fee. A consolidation loan also has an origination fee, and, of course, interest. In addition, there are probably late fees and penalties for missing payments.

Which Should I Choose, A Debt Management Program or a Debt Consolidation Loan?

That's a hard question to answer on a generic level. Since your situation is going to be unique, there may be factors that only a certified financial professional can identify. We recommend you contact one of the companies listed below, describe your situation in detail and see what they tell you.