Debt Management Plan Pros and Cons - Downsides of a DMP

Every debt management agency has a strategy, but because everyone's financial situation is different, it should never be a one-size-fits-all approach. There have been many accounts of indebted consumers who signed up for a debt management plan (DMP), only to come out further in debt and with worse credit than before. To get the most out of a DMP, it best is to know the potential downside going in.

Fraudulent or Deceptive Debt Management Companies

The most obvious downside is that some, though by no means all, debt management companies are more interested in making money from you than helping you solve your debt problems. The FTC and some states’ attorneys general have already sued several credit counseling agencies because the companies had deceived consumers about cost, the benefits they offered, or their nonprofit status.

The FTC advises consumers that are engaged in DMPs to be sure to check their bills on a regular basis to make sure that the debt management organization is fulfilling its obligations and paying bills according to schedule. If you pay into your DMP on time, but the organization doesn't turn the money around to your creditors as scheduled, you could still face penalties and fees and lose the benefit of any negotiated agreement that has been made.

You Have to Stay on Top of Your Debt Management Program

Once enrolled in a DMP it is easy to hand over the reins to the credit counselor and not pay close attention to the program's progress, and that could lead to trouble. Many money experts like Dave Ramsey warn that not being aware of your debt is what got you into debt in the first place. It is easier to prevent the recurrence of debt problems if you stay on top of what's being paid every month.

A DMP can make things easier for you, but just writing a monthly check and ignoring what's going on behind the scenes is a recipe for disaster. You must make sure you get regular updates from your counselor about all recent activities and your month-over-month progress.

One Missed DMP Payment Can Have a Huge Impact

When you put a credit counselor in control of your debt management, your only responsibility (and it's a huge one) is meeting the monthly payment. When you make the lump monthly payment to the debt management company, they then distribute it piecemeal to each of your creditors. Thus if you miss a monthly payment, ALL of your creditors do not get their monthly payment. The debt management company does not have any of your funds in reserve for non-payment months. The National Foundation for Credit Counseling’s study showed that 29% of Americans, or 58 million adults, admitted to not paying all their bills on time. Timely monthly payments are serious responsibility, but they are a small price to pay for having a debt management company negotiate lower payments and interest rates. Making the monthly payment is really all that is required of you under a debt management plan.

Debt Management Can  Affect Your Credit Score

Dave Ramsey warns that working with a debt management company does affect your credit score. Many companies report to the three credit bureaus that you are using a debt management company, which can impact any future loans or credit checks (like landlords often run when you are applying to rent an apartment).

Depending on the strategy you use, your credit also may be negatively impacted by raising your utilization rate, the ratio of your balance to your total available credit. Some credit management programs require you to close some credit card accounts, which lowers your total available credit and increases your utilization rate. Also, by closing out even some of your accounts, you lose the positive credit impact of credit account tenure. In time, though, consistent payments will negate any blemish on your credit report caused by working with a credit card debt management company.

Debt Management Fees

Many debt management companies charge a percentage of the total amount of debt as a payment for their services. This may seem counterintuitive to someone who is fighting to pay off creditors. However, according to the National Foundation for Credit Counseling, credit card debt management companies are funded additionally by contributions from creditors who participate in the debt management plans, and by local grants from private sources and foundations. The survival of the debt management company is not completely reliant on people who use debt management services. You must figure out for yourself if paying a debt management company is worth the money saved on creditors' interest charges.

Some Creditors Don't Want to Work with Debt Management Companies

Some creditors refuse to strike deals with debt management companies. This means that your debt with that creditor stays as is, including all late fees, current interest charges, and blemishes on your credit report. While the debt management plan may apply to your other creditors, you may wind up paying one payment to the debt management company and separate payments to any creditors that don't agree to your debt management company's negotiated terms.

Armed with the knowledge of the cons of debt management, you can make an informed decision as to whether or not to pursue an arrangement with a debt management company.