If you are having a problem managing your debts you may be tempted by an advert for a debt management company, which are regularly in newspapers and on television. These companies claim to be able to help you clear your debt quickly and save you money, but they are not always free. Before you reach for the phone, you need to understand what services these companies offer, how much they cost and if they right for you and your specific problem.
Repaying debt with a debt management company
Any debt you have will need to be repaid. There is no simple to solution to clearing debt, as the best option will almost always be repaying creditors as quickly as possible – nobody is going to wave a magic wand and make your problem disappear. We have a whole host of tips about debt management and budgeting to help you try to deal with this issue yourself. You should check out our article '4 easy ways to clear your credit card debt' and our 'Budget Planner – How to manage your money' page. Creating a sustainable plan to manage your money and deal with your debt may seem intimidating at first, but the process can a simple and easy way to get to grips with your finances.
If you are struggling to manage your debt and need an extra hand, keep in mind that any help provided by a third party does not need to cost you money. There is free debt help available from independent experts, which we explain how to find in our article 'Where to get free debt advice'.
If you are already using a debt management company or other Debt Management Plan (DMP) provider, you should at least understand how they work.
What is a Debt Management Plan?
A Debt Management Plan is the main tool used by debt management companies. It is an agreement that you will pay back your creditors in instalments that you can afford. A debt management company, or other DMP provider, will contact all the organisations you owe money to and negotiate a new payment plan. Most loan or credit card providers will agree to a reduced monthly payment rather than have you completely default on the debt and may, in some cases, freeze or reduce the interest being charged.
If an agreement is reached and your monthly payments are reduced, it will take longer for you to pay off any loan. This is because you are clearing your debt in smaller increments. The increased repayment period could also lead to you paying more overall, as there is more time for interest to build up.
The debt management company, or other DMP provider, will then usually manage the repayments to your creditors on your behalf by tracking what you have already paid and what more you still need to pay back. You will likely pay the money directly to the DMP provider rather than the lender you owe the money to.
FCA rules mean that DMP providers must tell you:
- where you can go for free debt advice
- if your first payment will be a fee (which would delay paying your creditors and increase your arrears)
- that creditors can continue other action to recover the debt, such as going to court
- to prioritise essential payments (eg. rent, mortgage payments, utility bills)
- not to ignore contact from creditors
- that the DMP could affect your credit rating
How will a debt management plan affect your credit score?
One major downside of a DMP that your credit score will be affected. This is because in order for the DMP provider to renegotiate with the creditors you owe money to, they need you to reduce your payments. In doing so, your partial payments are reported to credit agencies by the lenders and stay on your record for up to six years. This will leave a mark on your credit file for future prospective lenders to see and it will damage your credit score.
In some cases the money you initially pay the DMP provider will not be going towards your debt, but will actually be a fee. You should have been informed if this is the case, as it will mean you are missing payments.
Once the DMP renegotiations have taken place and a full agreement is reached, your monthly repayments to the debt management company will go towards clearing your debt, though there may still be some fees involved.
Will a debt management company or other Debt Management Plan provider charge a fee?
Not all DMP providers charge fees for their plans, but some do and what you will need to pay will vary. Debt charity StepChange claims that fee-charging providers will charge on average "around 17% of the monthly payment" and that a standard plan "could cost you an extra £4,000."
This a huge amount of money that could potentially be going to directly to clearing your debt, rather than to a debt management company. Avoiding a fee-charging debt management company could mean that you are able to repay your debt more quickly and avoid paying more in interest overall.
It is important to differentiate between fee-charging debt management companies and organisations that offer free debt help. For example, StepChange is a charity that can provide a DMP with no hidden fees, with every penny put towards your debts.
What is debt consolidation with a Debt Management Plan?
Debt consolidation consists of a new loan, arranged by the debt management company or Debt Management Plan provider, which is enough to pay off all your debts. This new loan is normally over a longer term than your current loans to enable the monthly payment to be reduced. The new loan could be secured against any property you may own as an added security for the lender, or unsecured and based more on your credit history. We explain the different options in our article 'Secured vs unsecured loans: Which is best for me?'.
Using a Debt Management Plan provider is far from the only way to consolidate debt. Consolidating credit card debt can be very simple, as we explain in our article 'How to do a credit card balance transfer in 5 minutes'. For over types of debt, read our article 'What is the best way to consolidate my debt?'.
Pros and cons of a Debt Management Plan
Here is a summary of the main advantages and disadvantages of using a debt management plan:
Pros of a DMP
- One monthly payment
- Prioritise essential costs and high-interest debts
- Some plans are free
- Interest can be frozen
- You only pay what you can afford
Cons of a DMP
- Some debt management companies charge huge fees, which reduces the share of your money going towards clearing your debt
- Creditors may not agree to the reductions you need to make the repayments affordable
- You can still be subject to court action to recover the debt
- Your credit score will be affected by reduced payments
Alternative options to manage your debt
Debt management companies should be avoided and are an increasingly rare sight, thanks to many struggling to keep up with FCA consumer protection rules. A DMP can be a solution to some financial situations, but you do not have to pay exorbitant fees or risk falling into more debt by using one. Debt charity StepChange offers a DMP with no set-up charges or monthly fees. You can also find out where to get more independent advice and debt help by reading our article 'Where to get free debt advice'.