What to do if you fail your debt management plan

If you've maxed out scads of credit cards and bill collectors are blowing up your phone, a debt management plan might seem like a magic solution. But what happens if your best intentions to comply with the plan backfire?

Millions of consumers seek help from credit counseling agencies each year, and one in three enroll in repayment plans known as debt management plans or DMPs, according to a paper published in 2012 in the Eastern Economic Journal. But this type of plan doesn't work for everyone, and seeing it through to the end isn't always an easy feat.

To get a client started with a DMP, the credit counseling agency typically negotiates a repayment schedule with creditors for debt that can include credit cards, medical bills and personal loans. Clients cannot include secured debts, such as car loans or mortgages. Then the consumer makes one monthly payment to the agency, which includes a small monthly fee. The agency then sends the correct amount to each creditor over a certain period of time, generally for a period of two to five years, depending on the amount of debt and the financial circumstances of the client.

Despite the simplicity of the plan, industry data show that less than half of consumers successfully complete DMPs. Most agencies and associations don't publish their numbers, but Cambridge Credit Counseling outlines its results in a yearly report.

The current report looks at outcomes both from a group of clients that began DMPs in 2008, to show long-term results, and a group that started in 2013. Just under 43 percent of the first group completed the program. Another 5 percent had either quit after paying off a large chunk of debt or were still working on repayment.

So, what happens to the more than 50 percent of consumers who drop out? Presumably, some eventually pay off the debt on their own, while others may file for bankruptcy. Of the Cambridge clients who left their DMPs, over half didn't give a reason, while 38 percent cited bankruptcy or financial problems.

"The goal is obviously to avoid bankruptcy," says John Szalicki, counseling manager for Cambridge. "But, in some cases, it's the right choice."

Debt management programs: Not a one-size-fits-all solution
A debt management plan through a legitimate nonprofit credit counseling agency that charges only a nominal fee is a good way for some consumers to get a handle on a debt problem, says Kelley Long, a certified financial planner for Financial Finesse, a financial education and planning company.

But credit counseling agencies' debt repayment plans tend to work best for consumers with enough disposable income to comfortably afford the repayments, according to the National Consumer Law Center.

In order to determine whether a DMP might be a good fit, a credit counselor must meet with a consumer first to look at the client's overall financial picture, household budget and the reasons behind the debt, Szalicki says.

A debt management plan offers several advantages that can give consumers a leg up in vanquishing debt. For example, most credit card companies offer a lower interest rate for everyone in a DMP, typically around 10 percent. Creditors also may waive late and over-limit fees for DMP participants.

"Every credit card company has its own policy," Szalicki says.

Also, when you sign onto a DMP, you can kiss your credit cards goodbye. Card issuers will close the accounts that are part of a debt management plan. This can be an inconvenience -- for example, if you want to use plastic to book a hotel room or rental car.

On the bright side, getting cut off from your cards can stop you from running up more debt. "It is an effective way to break you of a bad habit, cold turkey," says Long.

What happens if your DMP gets derailed?
It's not uncommon for a debt management plan to get off track due to financial issues that can crop up, says Thomas Nitzsche, a financial educator for ClearPoint Credit Counseling Solutions.

But even consumers who hit DMP snags might ultimately pay off their debt. That's what happened to LaTisha Styles, now a Memphis, Tenn., financial analyst who blogs at YoungFinances.com, and who got deep in card debt in college. She used plastic to pay for textbooks, groceries and even a pricey hotel on a trip to Florida. "I was doing everything I wanted to do as if it were my own cash," she says.

After she graduated and got a job, she had over $22,000 in debt spread out over more than a dozen cards. Eventually, she turned to ClearPoint to enter into a DMP.

About three or four times during her repayment plan, Styles said she couldn't make a payment. One month, she started getting hounded by a collection agency for a small debt that wasn't part of the plan, so she used her DMP money to pay it off. Another time, she spent a few hundred dollars too much on a birthday trip.

But her credit counselor helped her get over the bumps and finish her plan in about three years. "I was on phone with my counselor often," she says.

So, what typically happens when you run into problems making payments on a DMP? Here's what to expect in three scenarios:

  • A late payment. Some counseling agencies encourage clients on DMPs to set up payments by automatic debit from a bank account so there's never a delay in disbursements to creditors. A client who runs into money problems can suspend that month's payment and pay late with a cashier's check or money order. Because most credit card companies waive late fees for DMP clients, you might not have to worry about taking, say, a $35 hit, but it's important to talk to your credit counselor if you're going to be even a little late on a payment, Nitzsche says. "Some creditors are more lenient than others," he says. But, in general, being a few days or even a week late on a payment probably won't hurt you, Szalicki says.
  • A missed payment. What if your car breaks down or your fridge busts and you have to skip a month? Again, your counselor can give you advice. With some creditors, you can simply resume payments the following month with no problems, Nitzsche says. Some card companies, however, will drop you from the program right away, he says. If one of your creditors is a stickler, your counselor might advise you to pay just that portion of your total directly to that company, Nitzsche says. "They might say, 'go ahead and pay $30 to Bank of America, or whoever, so they don't drop you,'" he says.
  • You abandon your plan. Maybe you lose your job, get sick or just get too behind to catch up. In that case, you might join the ranks of consumers who walk away from a DMP. At Cambridge, once a consumer has missed three consecutive payments, the agency notifies creditors the DMP is no longer active. "Every agency has its own policy," Szalicki says. If you're having problems and you communicate, the agency will try to help you. "We'll do everything we can to get a client through hurdles," he says. If you do walk away and don't start paying the creditors on your own, your accounts likely will get sent to collections, Nitzsche says.
  • Some consumers should look into bankruptcy, which covers a broader range of debts than a DMP, according to Andrew Pizor, a staff attorney for the NCLC. "If you fail a DMP, you're likely to end up needing a bankruptcy," Pizor says.

    See related: How debt management plans affect your credit, When is a debt management plan a sound move?

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