Debt Consolidation vs. Debt Management

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As if debt weren’t difficult enough to deal with, the financial world seems to want to throw countless terms and definitions into the mix that all sound sort of the same but are basically different. Then they exchange them freely even though they’re defining one thing with a term from something else. When researching our options, it’s enough to want to throw our hands up in the air and give up.

No more.

You’ll notice on the ReadyForZero blog that we’re delving more and more into these definitions so you can fully understand all the options in front of you – and feel empowered enough to choose the one that works the best for you. Today’s definitions: debt consolidation and debt management.

Debt Consolidation Defined

What is debt consolidation? You may have already seen this definition in previous posts, but I’m on a mission to bring the confusion around this term to light. Ever since I started writing about personal finance, I’ve never seen a term that causes more confusion than this one. Call it poor financial education in the school system or call it predatory companies marketing their services in a manipulative way. Whatever it is, it’s rare to find a true definition of the word.

Here goes:

Debt consolidation is the act of combining one or more debt accounts into one.

So why all the confusion? Because many companies want you to believe that this isn’t quite so simple. They want you to believe that you need them to consolidate your debt.

You don’t.

In the strictest sense of the word, to consolidate debt is to simply combine one or more debt accounts into one. This typically happens through a new loan or line of credit that pays off the old ones. But in reality, you could even do it from person to person. Let’s say you are paying high interest credit cards and your family wants to help you. They can pay off your cards and set up a plan for you to pay them them back at less or no interest. That, in effect, is consolidating your debt.

You do not need a company to do this for you. There is not only one way to do it. And the benefit isn’t just to simplify your life, but to help you get a lower interest rate, thus allowing more of your monthly payments to go straight to principal so you can pay your debt off faster.

What Is a Debt Management Plan

A debt management plan (DMP) is a program in which you sign up with a company to take over your payments to creditors and they try to negotiate for more favorable terms. There’s no way to DIY a debt management plan – this is something a company does for you. However, understanding what you’re getting into can be difficult given the variety of names these companies may have. You might see this being advertised with a credit counselor, debt management company, debt settlement company, or even a debt consolidation company.

So how do you know if you’re signing up for the right thing? Know your lingo. A debt management plan (DMP) is more specific than the general term “debt management”, which can be applied to many companies and strategies for paying off debt. If you’re looking for a company that will take over your repayment for you without actually settling your debt, then you’re looking for a “debt management plan”.

While the idea of someone else handling your debt for you may sound like a relief, DMPs are not without risk or consequence. Here are a few more things to understand about DMPs:

  1. The company you sign up for will close your debt accounts and put you on a repayment plan. They’ll notify your creditors of this change.
  2. You’ll pay the debt management company and they’ll pay your creditors.
  3. You’ll be locked into a repayment term (such as five years).

And a few things to be mindful of:

  1. You will likely be charged an enrollment fee for the company as well as a monthly fee for their services
  2. Your credit could be impacted by the account closures.
  3. Your credit could be damaged if you or the company don’t make your payments on time. Anytime you’re allowing someone else to make payments on your debt accounts, you should take an active role in knowing your due dates (as they could change in this process) and ensuring your payments are made on time.

If you’re truly struggling with debt in such a way that you can’t meet your monthly obligations, this could be a good plan for you. But remember that it’s extremely difficult to pick out the good debt management companies from the bad. So keep in mind that “non-profit” does NOT equal not-predatory in this case. Be mindful of the fees. Read all the reviews you can find on the companies before choosing one. And review this information from the Federal Trade Commission if you do sign up for a DMP.

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Should You Try Debt Consolidation, a Debt Management Plan, or Neither?

The ultimate question – which, if any, of these options are the best for you? Simple question, complicated answer: it depends.

The best solution is always manage your debt on your own if you can. You then have full control over your situation and your credit. You can pursue debt consolidation before you get started to get the most favorable rates possible. You could call your lenders and negotiate with them. You could start a new budget and look for ways to earn extra money to turbo-boost your plan.

But if you’re struggling in such a way that you can’t meet your monthly obligations, you may need to seek outside help in the form of a debt management plan or possibly even bankruptcy. Just remember – these aren’t cure-all solutions. They will cost you money, they could affect your credit score, and they don’t guarantee that you won’t end up back in debt later.

The true salve to any debt payoff plan comes from you. Finding a plan that will truly work best for you. Learning more about your financial beginnings and how they affect you now. Discovering the financial strategy that will prevent you from ever having to deal with debt again.

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  • Debt consolidation can be a part of debt management plan, by consolidating all debts into a single debt.