Debt Management Plans vs. Debt Settlement: What's the Difference?

If making your monthly debt payments has become difficult, you’re not alone. You may be looking for ways to gain control of your debt, either by making it easier to repay or reducing how much you owe. Debt management plans and debt settlement are two common — yet very different — approaches. Let’s explore how each one works, how they may affect your credit score and some alternatives worth considering.

What is a debt management plan?

A debt management plan (DMP) is a structured debt-repayment program designed to help you repay multiple debts over time. A DMP is typically arranged through a credit counseling agency that works with you and your creditors to create a plan to repay your debts.

A DMP could help you pay off unsecured debts, like credit cards and personal loans, in three to five years.¹ Unsecured debt is not backed by collateral — something of value that you own. Secured debts, such as mortgages or auto loans, aren't usually eligible for DMPs.

How does a debt management plan work?

The first step is finding a credit counseling agency to work with. Credit counseling agencies are usually nonprofits. Look for one accredited by the National Foundation for Credit Counseling (NFCC).²

Once you've chosen an agency, you'll meet with a credit counselor to review your income, expenses and debt. Together, you'll determine whether a DMP is a good fit for your situation. If so, the counselor will provide you with an action plan for paying off your debt. If you agree to the plan, you can enroll. You may be asked to sign a contract and pay a setup fee of up to $75, as well as a monthly fee of up to $50 for the duration of the plan, unless you qualify for an income-based waiver.³ A typical credit counseling agency will be upfront about its fees and won't charge you before providing services.⁴

After you enroll, the agency will contact your creditors on your behalf and may ask for adjusted terms, such as lower interest rates or waived fees. From there, you would make one monthly payment to the agency, which distributes the funds to the creditors for those debts enrolled in the plan.

How does a debt management plan affect your credit?

Working with a credit counselor won't directly impact your credit score.⁵ However, when you enroll in a DMP, your creditors may add a note to your credit report. But that note isn't considered negative.⁶

Creditors often require you to close your credit card accounts when entering a DMP. Closing accounts can lower your overall available credit, which may increase your credit utilization ratio and temporarily negatively impact your credit score. But making consistent, on‑time payments into the plan your creditors have arranged could put you on the road to improving your credit score over time.⁷

How does a debt management plan affect your taxes?

Generally, if you have a DMP, the plan does not affect your taxes since you are repaying your debt. When you repay the full balance that you owe, the DMP has no direct impact on your taxes. However, if a creditor forgives or cancels part of your debt, the taxable amount is typically reported as income to the IRS.⁸

What is debt settlement?

Debt settlement involves negotiating with your creditors to reduce or potentially eliminate a portion of your debt. You may try to negotiate on your own, or you may hire an attorney or a debt settlement company, also known as a debt settlement agency (DSA), to negotiate on your behalf for a fee.

A DSA is generally a for-profit company that charges a fee to try to make arrangements to settle your debt with creditors and debt collectors, often after the account has become delinquent, or significantly past due. It’s important to understand that debt settlement is risky and can cause long-lasting negative effects on your credit score.

DSAs can't always settle 100% of your debt. In fact, there’s no guarantee a DSA can settle any of your debt at all, since some creditors won’t negotiate with DSAs. Because late fees and other expenses can pile up during negotiations, the Consumer Financial Protection Bureau (CFPB) warns that settling a debt may leave some people deeper in debt than when they started.⁸

How does debt settlement work?

During the debt settlement process, you may be asked by the DSA to stop paying your creditors directly while they negotiate on your behalf.⁹ Instead, you make monthly payments into a bank account managed by a third party. If the DSA is successful, it pays your creditors using the money in that account. DSAs generally charge fees of between 15 to 25% of your enrolled debt. Debt settlement companies may charge fees in different ways. The fee may be based on a percentage of the debt they settle or a percentage of the money you save through the settlement. A company can generally only charge a fee after a creditor has agreed to a settlement amount and the first payment has been made. That means you may be charged a fee before your debt has been completely settled. The timeline for debt settlement varies but can often take three to four years.¹⁰

How does debt settlement affect your credit?

Debt settlement is considered a risky strategy because the longer the debt goes unpaid, the more it can negatively affect your credit score.

Missing or reducing payments during the debt settlement process can severely affect your credit score. Many creditors won't consider settling an account for less than what's owed if the account is in good standing. You may need to miss several payments before a creditor is willing to negotiate, which has a significant negative effect on your credit score.

The impact of missed payments on your credit score increases as more billing periods pass. According to Experian, accounts more than 90 days past due may lead to further consequences, including potential legal action by the lender.¹¹

Delinquent debt may appear on your credit report for up to seven years.¹² Even if a debt is settled successfully, it may still be reported as “settled” rather than “paid as agreed,” which could affect how future lenders view your credit history. Having settled debts on your credit report may make it more difficult to get approved for mortgages, credit cards, auto loans and other forms of credit in the future. If you do get approved for new credit, lenders may charge a higher interest rate due to perceived risk.¹³

How does debt settlement affect your taxes?

If a creditor forgives or cancels part of your debt during debt settlement, the canceled amount is usually considered your taxable income. However, some exceptions may apply, such as if your total debts were greater than the value of your assets when the debt was canceled, or if the debt was discharged through bankruptcy.¹⁴

Debt management plans vs. debt settlement: What to consider

Choosing between a DMP and debt settlement depends on your individual financial situation. Here are some factors to think through:

• Type of debt: DMPs are generally designed for unsecured debts like credit cards and personal loans. Secured debt, which is debt backed by collateral such as a car or home, generally isn't eligible.¹⁵ Debt settlement may be available for other types of unsecured debts, such as debt judgments. A debt judgment is a court ruling allowing a creditor to garnish your wages or take other actions to recover the judgment. However, settlement is not guaranteed.¹⁶
• Ability to make payments and cover fees: A DMP requires steady, on-time monthly payments over three to five years. If your income is stable enough to support that kind of commitment, a DMP may be worth considering. Debt settlement, on the other hand, often involves stopping payments altogether for a period of time, which may lead to your creditors charging late or missed payment fees. The DSA can also charge a fee after the first payment has been made to a creditor, which may lead to higher initial payments.
• Desired timeline for repayment: A DMP has a defined end date — typically three to five years. Debt settlement timelines vary and may take longer, with no guarantee of a resolution. Plus, if negotiated payments are stopped for any reason, the settlement agreement may be canceled, and you may not recoup any of the fees you’ve paid the DSA.
• Creditors’ willingness to work with third parties: Not all creditors are willing to work with a credit counseling agency or a DSA. Check to make sure your creditors are willing to participate before enrolling in either a DMP or a debt settlement plan.

Alternatives to debt management plans and debt settlement

If neither a DMP nor debt settlement feels like the right fit, you could consider one of these options.

• Debt consolidation loan: A debt consolidation loan may be your best choice if you want to combine multiple debts into one personal loan, usually with a more manageable monthly payment and a fixed interest rate. With a debt consolidation loan, you make one monthly payment for the new loan, and you’ll have a set payoff date as long as you make your payments on time. This means as long as you make your monthly payments on time, you’ll know when the debt will be paid off. OneMain offers debt consolidation loans from $1,500 to $30,000.
• Credit card with a balance transfer offer: A balance transfer involves moving existing credit card debt to a card with a 0% or low promotional annual percentage rate (APR) for a set period. APR is how much it would cost to borrow money for a full year, including interest and fees. If the offer period lasts less than a year, then the promotional APR will last less than a year, and the remaining unpaid transferred balance will be subject to the card’s higher APR when the promotional rate expires.
• Debt repayment strategies: If you want to tackle your debt on your own without using debt relief methods or DMPs, the debt snowball and debt avalanche methods are two structured approaches to paying down your balances in full over time. The snowball method focuses on paying off the smallest balances first, while the avalanche method prioritizes paying off debts with the highest interest rates first. Both methods require that you still pay at least the minimum monthly payment due for all of your debts.
• Negotiating directly with creditors: Some creditors may offer hardship programs or alternative payment terms if you reach out and explain your situation. Contact your creditors directly to ask what options may be available.
• Bankruptcy: Bankruptcy is a legal process that may reduce, restructure or eliminate certain types of debt. Filing for bankruptcy can have significant financial and credit implications and is generally considered a last resort.

Two different approaches to debt

Debt management and debt settlement are two very different approaches to addressing unmanageable debt. A DMP focuses on structured, full repayment over time, often with the support of a nonprofit credit counseling agency. Debt settlement focuses on negotiating a reduced payoff, but it carries significant financial and credit risks, especially when working with for-profit debt settlement companies.

Both options have trade-offs, and what makes sense for one person may not make sense for another. Before making a decision, take time to research your debt relief options and understand the potential impact each one could have on your credit score.

Sources

1, 6 https://www.nerdwallet.com/personal-loans/learn/how-does-debt-management-work
2, 3, 7 https://www.nfcc.org/blog/which-debt-repayment-method-is-right-for-you/
4 https://www.consumerfinance.gov/ask-cfpb/how-can-i-tell-a-credit-repair-scam-from-a-reputable-credit-counselor-en-1343/
5 https://www.myfico.com/credit-education/blog/debt-management-score
8 https://www.irs.gov/newsroom/what-if-my-debt-is-forgiven
9 https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-relief-program-and-how-do-i-know-if-i-should-use-one-en-1457/
10 https://consumer.ftc.gov/articles/how-get-out-debt
11 https://www.nfcc.org/resources/debt-settlement/
12, 13 https://www.experian.com/blogs/ask-experian/when-does-debt-become-delinquent/
14 https://www.cbsnews.com/news/can-i-use-my-credit-card-after-debt-settlement/
15 https://www.irs.gov/taxtopics/tc431
16 https://www.nationaldebtrelief.com/blog/financial-wellness/financial-education/can-you-settle-a-debt-after-judgment-options-and-strategies-explained/