Understanding the Difference Between Debt Settlement and Debt Management

Many of us reach a crossroads when navigating debt, especially in the face of high credit card interest rates, inflation, and any unforeseen changes in household income.

If you’re navigating credit card payments and other debt, it’s helpful to consider the best approach for your situation. To help you weigh your options, here is an overview of two approaches: debt settlement and debt management.

Debt Settlement

• Debt settlement typically involves requesting credit card companies to forgive a portion of your debt in exchange for a lump sum payment.
• You provide the names of your creditors and the amount of outstanding bills to the debt settlement company.
• The debt settlement company provides an estimate for reducing your debt along with a new, lower monthly payment. As advised by the settlement company, you stop paying your creditors and instead send payments to the debt settler.
• Typically, your payments are held until enough funds accumulate to make a settlement offer to a creditor. In the meantime, your accounts could be falling farther past due resulting in stressful collection activity.
• Once funds accumulate the settler handles the negotiation with each creditor. This process happens over several years.

Costs of Debt Settlement

It’s helpful to take a close look at the costs involved when working with a for-profit debt settlement company.

• Debt settlement companies charge 15 to 25 percent of your enrolled debt.
• Forgiven debt may be considered taxable income so you need to check with your tax professional.
• If you settle a debt, you will pay your creditor the agreed lump sum, then pay a 15 to 25 percent fee to the agency, and then possibly a tax bill.

Impact on Credit Scores with Debt Settlement

A debt settlement firm may advise you to ignore all the missed payment notices sent to you by credit card issuers. Missed payments means your credit score will go down in the short-term.

Any missed payments remain on a credit report for seven years. Until you replace the negative payment history with some positive information, you’ll have difficulty getting new credit cards and loans.

Debt Management

• Debt management programs through credit counseling consider your current financial picture, from outstanding credit card payments to overall financial health.
• Payoff timeline is typically 3 to 5 years which includes paying off debt, rebuilding credit and making progress toward financial goals.
• After the counselor understands your specific situation, they work with you to build a debt management plan that consolidates your debt into a single payment.
• Your creditors are contacted immediately upon enrollment so they are aware of your situation, can note your account, and in many cases stop collection activity.
• The program works to ask your creditors for concessions such as lower interest rates and monthly payments with creditors, so if allowed you can pay off debt faster and save money.
• Each payday, you automatically deposit money into your account, and that money is then paid to your creditors on your behalf.
• Debt management plans are designed to pay off the entire amount you owe.

Costs of Debt Management

• Setup and monthly fees vary based on state of residence and debt amount.
• As an example, GreenPath’s one-time setup fee that ranges from $0 to $50 and a monthly fee that ranges from $0 to $75.
• A minimal cost when offset by the amount of money saved in waived late fees, waived over limit fees, and reduced credit card interest charges across time.
• When a debt management plan can lower your interest rates, the total amount you pay to your credit card company is typically less than if you paid on your own.

Credit Scores with Debt Management

With debt management, your credit score may drop initially when your credit accounts are closed.

Typically, by the end of a debt management plan, your credit score rebounds because you will have reduced your debt load and you will have a consistent history of on-time payments.

Next Steps

To help figure it all out, many people gain clarity by calling a GreenPath financial expert. When you call, you’ll talk to one of our NFCC-certified counselors. We’ll review your financial situation together, and make a personalized plan to get your finances back on track.