How does a debt management company work?

If your debt is piling up, and you’re finding it tough to stay on top of your payments, you might be looking for some relief. One option to consider is working with a debt management company.

Getting relief can seem even more pressing if you’ve already missed some payments, which causes your credit score to drop, interest rates to go up and late fees to kick in — all of which makes it even harder for you to stay current on your bills.

There are several options for handling debt, from credit counseling and debt settlement to a loan or even bankruptcy. A debt management plan, offered through a credit counseling agency, a.k.a. a debt management company, is also one way to help get your debt under control.

What is a debt management plan?

With a debt management plan, a credit counseling agency negotiates with your creditors to lower your monthly payments through reduced interest rates and reduced or eliminated penalties. They then come up with an agreement on how much you’ll pay each month with the goal of paying off your debt in a three- to five-year window.

Only unsecured debt like credit cards, medical bills, or bank issued personal loans can be included in a debt management plan. They can’t be used for debts secured by collateral like a mortgage or a car loan.

Instead of paying your individual creditors each month, you make one monthly deposit (often automated) into an account held by a credit counseling agency. The agency is then distributes that money to your creditors.

The major upside of these plans is that you should see your monthly payments go down due to lower interest rates and reduced or eliminated penalties. Which should make paying off your debt more realistic.

What does a debt management company do?

Only credit counseling agencies can enroll you in a debt management plan. So if you’re interested in debt management, first do some research to find a reputable agency. A good starting point is the U.S. Department of Justice’s list of approved credit counseling agencies by state.

Choose an agency that has certified credit counselors who are trained in consumer credit, budgeting, and money and debt management. A credit counselor should be able to give you advice on managing your money and debts and offer you free educational materials and workshops.

Most credit counseling agencies are nonprofit, but that doesn’t mean all their services are free or cheap. Make sure you know the costs upfront. Typical monthly fees for handling a debt management plan range up to $50.

If possible, meet with a credit counselor in person. He or she should spend time going over your finances and making recommendations. A credit counselor will typically only walk you through the benefits of a debt management plan. But if you both agree that a debt management plan is the best option, then your credit counselor will help you figure out how much you can afford to pay each month while keeping up with your other expenses.

Each month, you’ll make your payment and the credit counseling agency will pay your creditors. Your credit cards and loans that are enrolled in the plan will continue to send you your monthly statements. Even though you’re not paying your creditors directly, keep a close eye on the process by opening those statements to be sure all payments are being applied correctly. The credit counseling agency should also help you make adjustments to your plan if your situation changes.

Pros & cons of debt management

It’s important to take your time and really weigh your options before you enter into a debt management plan. These plans are long — three to five years — and missing even just one payment can mean losing the negotiated benefits like the lower interest rate. So before you say yes, make sure you can hang in there for the long haul.

Also keep in mind that the credit counseling agency may ask you not to apply for, or even use, credit while you’re on the plan. However, many companies are okay with you keeping one credit card outside the debt management plan. You also can still apply for loans and mortgages while you’re on a debt management plan.

Once you’ve paid off your debts, your accounts will be closed. If you’re closing a lot of old accounts, it could impact the age of your credit and therefore cause your credit score to drop. But you also could see some real benefits to your credit score by making timely bill payments and lowering your debt-to-income ratio.

Related article: 5 steps to rebuild credit after debt management

Most importantly, the reduced interest rates and/or fees that come with a debt management plan gives you a better shot at paying off your debt. You also won’t have to worry about debt collectors calling or being sued once you enter into a plan.