There are a lot of military families who end up needing help with managing their debt. Although many people are able to buckle down and work their way out of debt, others may need external help. One of the most common resources people turn to is a debt management plan (DMP).
A debt management plan is a relationship that you establish with a counseling agency who might be able to negotiate a lower payment or lower interest rate to your creditors. In exchange, you pay the agency, who then pays the creditors directly. All this is done for a nominal set-up fee, as well as a monthly fee to continue the plan, which usually lasts from 36-60 months. (For more, see: The Best Life Insurance for Military Families.)
Sounds great, huh? Before you sign up, there are several things you should consider before entering into a debt management plan.
Point 1: The Right Solution?
Debt management plans should not be considered "one size fits all" type solutions. Many providers who administer debt management plans seem to push a boiler-plate solution to anyone who might be able to afford it. This happens even if a debt management plan is not the right solution for that person’s particular situation. Some people might not need a debt management plan, while others might have debts that cannot be covered.
For example, secured debts (car loans or mortgages) cannot be covered under a debt management plan. Before you sign up, you’ll want to make sure that a DMP is the right solution for your particular situation.
Point 2: Fees
Pay attention to the fees involved with debt management plans. You might save money by paying less in credit card interest. However, that’s small consolation if DMP fees cancel out your savings. You can expect to pay an initial fee, as well as monthly fees for as long as you’re in the program. According to Military.com, you should avoid plans that require an initial fee higher than $50 or monthly fees higher than $25. (For more, see: How to Create an Effective Budget.)
Point 3: Credit Score
Your credit score might take a hit. First of all, you can expect some (or all) of your credit card providers to do any of the following:
- Stop extending you credit
- Not allow you to open new credit accounts
- Not allow you to use your credit card at all
When credit card companies start to close your accounts, the credit agencies reflect that as a lower amount of available credit. This is what lowers your score.
Second, creditors have been known to report to credit agencies that you’re not making the full agreed-upon payments. This might occur even after the creditors accept the reduced payment as part of your debt management plan. Keep your eyes on your credit report while you’re in a DMP so you know what’s happening. You’ll want to be in constant communication with your credit counselor on next steps if you notice something wrong with your credit report.
Point 4: Low Completion Rates
Debt management plan completion rates are pretty low. Although debt management plans are supposed to last 36-60 months, most people quit before the program ends. This means they’ve paid the fees and may have already had their credit accounts frozen. However, they’ll eventually have to start over to pay down that debt or file bankruptcy.
Perhaps it’s optimistic to think that these people may have finished the program early or started paying it off on their own. However, Cambridge Credit Counseling, a leading DMP provider, states that 38% of its clients leave due to either bankruptcy or financial problems.
Point 5: DIY?
You might be able to achieve the same thing on your own. First of all, you’ve got to determine whether you’re serious. If you know that you’re going to set aside as much money as possible to pay down your debt and get back into the black, then you should look into whether you actually need a DMP. You might find that with a little work and discipline, you can get the same effects (lower payments, gradual debt payoff) without having to rely upon a credit counselor. Below are a couple of options:
You might be able to transfer your balance to a zero-interest card. A lot of credit card companies offer an introductory 0% APR (annual percentage rate) for a certain period of time. You’ll want to be careful that you know if there are any account transfer fees, and exactly what period of time you’re able to do this for. However, this might be a quick win if you’ve got one or two cards that you could pay off in a year or less. (For more, see: How to Use Your Credit and Debit Card Safely.)
You can also contact your credit card company to negotiate a lower rate. This could work especially in cases where you can demonstrate that you have a proven history with that credit card company and that you’ve paid your bills on time. Most companies will work with their valued customers to prevent them from moving their accounts.
You could also use a lower-interest form of debt, such as home equity. However, using a home equity line of credit (HELOC) will probably encourage you to make bad decisions. If you get used to relying on a HELOC to bail you out every time you feel a financial pinch, you might not pay down debt. The only way you can avoid this is by establishing a plan and sticking to it. Most people have great intentions but fail to follow through after the first few months. This is one of the reasons I do not recommend a HELOC as a substitute for emergency savings.
Fortunately, in the military, you don’t even need to try this on your own. You’ve got other available options before you resort to a debt management plan. You should definitely talk to your installation’s financial counselor before making any type of commitment to a DMP. Your financial counselor will give you an honest assessment and help you make the right decision for your situation. While this may or may not include enrolling in a debt management plan, you can rest assured that your advice comes from someone who doesn’t have a conflict of interest. (For more, see: The Ultimate List of Painful Financial Mistakes.)