As of 2022, the average American owed just under $5,589 in credit card debt. Although credit cards can make purchases easy, managing your debt and making timely payments isn’t always as simple.
There are many ways to manage your debt, including the debt snowball method or working with a credit counseling organization. Creating a debt management plan that fits your budget and financial situation is important in getting your debt under control.
What is debt management?
Debt management can be a difficult process, but it is possible to get your debts under control through financial planning and budgeting. The goal of a successful debt management plan is to use these strategies to lower your current amount of outstanding debts and eventually eliminate them.
There are two ways that you can go about creating an effective debt management plan. The first option is to do it yourself, which has the advantage of being simpler. However, sometimes it can be helpful to have an outside partner providing help or accountability. The second option is to go through credit counseling, which can offer more comprehensive assistance.
How does debt management work?
Debt management plans help you pay off your unsecured debts, like credit cards and personal loans. There are two ways to do this:
A DIY approach to debt management
In this version of debt management, you take control of your budget and work to pay off your debts while maintaining your financial stability. You can use budgeting calculators and repayment apps to help keep you on track and may need to negotiate with creditors to lower monthly payments or interest rates. Once your debt is under control, you can decide whether to keep or close accounts.
Credit counseling for debt management
This involves working with a professional counselor to get a handle on your finances and work out a plan to pay off your debt.
There are both nonprofit and for-profit credit counselors, so be sure to do your research before you choose one. Read reviews and understand any fees you might be charged before signing up for a credit counselor.
Credit counseling can help you develop a plan to repay your outstanding balances and, in some cases, negotiate debt management plans (DMPs) with your creditors. DMPs typically last for three to five years and may involve concessions from your creditors, such as lower interest rates or reduced monthly payments. Depending on your circumstances, your creditors may close your accounts as each debt is repaid to avoid creating any new debt.
Debt relief company
There are many options available to help resolve outstanding unsecured debts. One such option is to hire a debt relief company. These for-profit entities work with creditors and lenders to reach settlement deals for less than the full outstanding balance.
When signing up for this service, customers will make monthly payments into an account held by the debt relief company. In the meantime, many debt relief companies will advise customers to halt payments to creditors and lenders to speed up the negotiation process.
The debt relief company will settle with your creditors. Once the settlement is reached, you will be presented with the terms. If you agree to the terms, the funds in the account you have been making payments into will be used to make the payment. The debt relief company will also collect a settlement fee from the same account.
How does debt management affect your credit score?
Debt management can be a helpful way to get your debt under control. However, it is important to be aware that it can also negatively affect your credit score.
As you work to manage your debt, there may be times when you trigger what’s called a hard inquiry. This usually happens when you try to get lower interest rates.
Hard inquiries stay on your credit report for two years and can have an impact on your credit score for one year. Although this might sound like bad news, it’s not that big of a deal. In the grand scheme of things, it’s just a short-term effect.
Plus, there are easy ways to offset the negative impact of hard inquiries. For example, by successfully lowering your interest rate, you’ll also improve your monthly payment history. And payment history is 35 percent of what determines your credit score.
It’s important to make consistent payments on your debts, as this will help improve your payment history and credit score. However, missing payments can cause your credit score to drop significantly. So, be careful with any strategies (like withholding payment from your creditor)
Credit utilization is one of the key factors that determine your credit score. This factor, which makes up 30% of your score, is linked to the amount of debt you carry in relation to your available credit. Ideally, your debt should not exceed 30% of your available credit across all accounts.
Consolidating all your debts into one bill can help pay them off. However, closing some of your accounts can negatively impact your credit mix (10% of your score) and credit history (15% of your score).
Debt financing options
Debt management is not the only way to handle debt. There are other options you can consider that may be a better fit for your current financial situation:
Balance transfer credit cards
With a zero percent introductory interest rate, you can pay off your debt without accruing any additional interest. However, keep in mind that there are usually fees associated with a balance transfer, such as a fee for each transfer. Additionally, unless you’re transferring your balances to a pre-approved card, doing so may result in a hard inquiry on your credit report.
Generally speaking, you need good to excellent credit to qualify for a balance transfer card. And even then, it’s important to have a plan in place for how you’ll repay your debt before the zero percent interest period expires. Once it does, you’ll be subject to the regular variable APR, which will likely be higher than what you’re paying now.
A lump sum of money can be a lifesaver when it comes to paying off debt. A long-term loan gives you the breathing room you need to get your finances under control. Loans typically have a repayment period of two to seven years, and you’ll be expected to make all payments by the end of that time. With a loan, you won’t have to worry about making minimum monthly payments like you would with a credit card.
The interest rate you’ll get on a personal loan depends on several factors, including credit score. Interest rates can range from 5 to 36 percent, so it’s important to compare rates before you apply for a loan.
Are you a good candidate for debt management?
Debt management can help you get out of debt, but it’s not a cure-all. With secured debts like mortgages, it may not be an option. However, it might be something to explore:
- Have numerous high-interest, unsecured debts like credit cards.
- You’re approaching or at the maximum credit limit for each account.
- Have a trustworthy income to make your payments.
- Don’t anticipate needing to open a new credit account during your DMP.
- Prefer that an agency or company negotiate your DMP rather than DIYing it.
- Have addressed risky financial habits, like overspending.
Debt management can be a difficult and overwhelming process. Fortunately, there are options available to help you get the relief you need and deserve. Debt management options, like the debt snowball, debt avalanche, DMPs, and debt settlement, can help you get rid of your debt. However, they are not all created equal. Some strategies have more long-lasting adverse effects than others.
You may also find another financing option, like a balance transfer credit card or personal loan, that is more suitable. Weigh the benefits and drawbacks of each debt management method to make an informed decision that helps you meet your debt-payoff goal in record time and works best for your financial situation.