Debt 101: debt settlement vs. debt consolidation vs. DMPs

Debt is common, with people increasingly using credit cards or loans to cover various types of expenses. Although credit can be convenient and helpful in many cases, it can easily get out of hand. According to the Urban Institute, the median amount of debt in collections — meaning the debt has been sold to a collections agency and may be incurring costly fees —  is $1,739 per borrower. 

If you’re struggling with high balances and interest rates, there are several ways to pay off your debt faster and save money. Three common strategies are debt management plans, debt consolidation and debt settlement. Although these approaches may sound similar, they’re very different from one another, and they’re not suitable for all situations. 

What is debt settlement?

Debt settlement, which is often referred to as debt relief, is a process where a company is authorized to negotiate with your creditors to settle your debt for less than you owe. If successful, the savings can be significant; you could reduce your balance by as much as 50%, allowing you to save thousands. 

However, it’s a risky process. 

“If your accounts are up to date at the time you enroll in debt settlement, they’re going to tell you to force those accounts into delinquency, which is often a tactic they use to try to improve their negotiating position,” said Bruce McClary, senior vice president of membership and communications with the National Foundation for Credit Counseling. “But unfortunately, it’s your good credit rating and your finances that are on the line.”

By pausing your payments, your credit score may be damaged, and there’s no guarantee of success. Some creditors have policies that prohibit negotiations with debt settlement companies, so it won’t stop collections activities or legal proceedings. 

Companies also charge hefty fees for their services; in general, they charge 15% to 25% of your enrolled debt. And if they are successful in negotiating a settlement, the forgiven amount is considered income for tax purposes, so you could face a substantial tax bill. 

Debt settlement can be an effective tool as a last resort, but it can only be used for unsecured debt and private student loans. Secured loans and federal student loans aren’t eligible. 

What is debt consolidation?

Debt consolidation refers to a process where you take out an unsecured personal loan and use it to pay off your existing credit card balances and other debt. Going forward, you’ll have one monthly payment.

Personal loans usually have lower rates than credit cards, so those with credit card balances may find that debt consolidation can help them save thousands in interest charges and get out of debt faster. And because the loan pays off your existing balances, your credit utilization is improved, and you could see a boost to your credit score. 

Although debt consolidation can be effective for some borrowers, it doesn’t solve the issues that caused you to get into debt in the first place. Without figuring out the root causes, you may just worsen the issue.

“If, for some reason, you’re unable to pay it, then you end up in even more debt than you started with,” cautioned Block. 

To qualify for the lowest possible rates, you’ll generally need very good to excellent credit, and not all forms of debt can be paid off with a debt consolidation loan. For example, many lenders prohibit using a debt consolidation loan to pay off secured debt or student loans. 

What is a debt management plan (DMP)?

A DMP is a program available through non-profit credit counseling agencies. When you enter into a DMP, the credit counseling agency will contact your creditors on your behalf. Based on the agreements they’ve negotiated with many major companies, banks and credit unions, they’re often able to convince your creditors to lower your interest rates and waive late fees, helping you save money. 

“Non-profit credit counseling agencies have relationships with the different creditors, so we can lower the interest rates pretty significantly,” said Madison Block, product marketing manager with American Consumer Credit Counseling. “So, your interest rate [on existing credit card debt] might be more than 20%. And we can get that down to close to zero in some cases.” 

You make a single payment to the credit counseling agency, and they take that payment and disburse it to your creditors based on an agreed-upon repayment plan. The counselor will work with you to develop a budget and spending plan to help you stay on track. 

Under a DMP, you can become debt-free in three to five years, and you could potentially save a significant amount of money. 

DMPs do require setup fees and monthly account fees. But because DMPs are operated by non-profit agencies, the fees tend to be relatively low, and, if you have a lower income, you may qualify for fee waivers or reductions. 

However, DMPs are typically only for unsecured debt, such as credit card balances and medical bills. Other forms of debt, such as mortgages, auto loans or student loans aren’t eligible. You also have to agree to close your credit accounts, so if you rely on credit cards, going without credit can be challenging.

The takeaway 

If you’re struggling with debt, deciding on a path forward can be daunting. DMPs, debt consolidation and debt settlement are commonly-recommended strategies for digging yourself out of debt, but they are very different processes with their own pros and cons. Understanding how they work, their benefits, risks and fees can help you make an informed decision. 

When evaluating your options, be aware that scams and fraudulent companies are common. Do your homework on the organization before making any commitments. 

“Don’t feel pressured to make a decision in the moment while you’re on the phone,” McClary warned. “Give yourself a fair amount of time to think about the different options you have and make the right decision.”

If you aren’t sure where to begin, meeting with a non-profit credit counselor or a credentialed financial advisor can help. They will review your finances and debt and identify all of your potential options, including the potential for government relief programs, so you can decide on next steps. 

To find a reputable counselor or advisor, visit or 

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