You’ve considered bankruptcy to get relief from your overwhelming debt but fear the long-term consequences that come with it. Is a debt management plan a better option? Keep reading to learn more about both forms of relief and how they differ to make an educated decision.
What Is a Debt Management Plan (DMP)?
A debt management plan (DMP) is a program that helps consumers get a handle on unsecured debt. They’re offered through credit counseling agencies and operate as follows:
- Step 1: You meet with a credit counselor to review your finances.
- Step 2: You enroll in a DMP, and the credit counselor negotiates with your creditors to get concessions, like a reduced interest rate, late-payment waivers and re-aging of your accounts to bring them current.
- Step 3: You make a single monthly payment to the credit counseling agency for a set period. Each month, the payment is divided up and sent to the creditors to satisfy the terms of the DMP.
You can include credit card debt, personal loans, consolidation loans and in-store credit lines in a DMP. Some collection accounts for utilities, service contractors or unpaid medical bills can also be rolled into a DMP. However, outstanding debts associated with secured loans, like auto loans and home loans, along with student loans, alimony, child support and tax debt, are ineligible for inclusion in a DMP.
What Is Bankruptcy?
Bankruptcy refers to a form of debt relief that consumers use to get a clean slate or repayment plan that gets them out of debt faster. It also alleviates the added stress from collection calls and more severe collection activities, like wage garnishment and lawsuits.
Chapter 7 bankruptcy (or liquidation) forgives most unsecured debts and usually takes three to four months. However, you’re required to pass a means test to qualify for this form of bankruptcy. Also, any assets that you have that don’t qualify for an exemption will be liquidated (sold) to repay your creditors.
Chapter 13 bankruptcy (or wage earners bankruptcy) gets you into a court-ordered repayment plan that spans three to five years. Upon successful completion of the plan, the remaining balances on the covered debts will be discharged. Like Chapter 7, it also requires you to make a mortgage, auto loan and other secured debt payments to keep your assets. However, you could be permitted to include your home loan or auto loan in the payment plan to bring the accounts current.
Bankruptcy versus a Debt Management Plan: How Do They Compare?
Before deciding which option is best, be mindful of the benefits and drawbacks of each. It’s equally important to understand the critical differences between the two.
Bankruptcy versus a Debt Management Plan: Pros and Cons
Benefits of bankruptcy:
- Your debts will be discharged (except for tax debt and past-due child support) under Chapter 7.
- Chapter 13 also discharges your debts once you complete the repayment plan. However, you’re mandated to pay non-dischargeable debts in full under the plan.
- Bankruptcy creates an automatic stay that prohibits creditors from pursuing further collection activity.
Drawbacks of bankruptcy:
- Your credit score will take a significant hit when you file for bankruptcy.
- You can only file for Chapter 7 if you pass a means test, which means your income (after expenses) cannot exceed the median income limit for your state.
- You have to seek permission from the bankruptcy court to open new debt accounts if you file Chapter 13.
Benefits of DMPs:
- Your creditors could agree to concessions to help you save in interest or fees or re-age the accounts to bring them current.
- You could shorten your repayment period by several years.
- Your credit counselor can provide tips to help you manage your finances more effectively, meet your money goals and stay out of debt when the DMP ends.
Drawbacks of DMPs:
- Your creditors aren’t obligated to accept the terms of a DMP.
- Credit cards included in the program will be closed as they are paid off and you cannot apply for new credit cards until you leave the program.
- If you fall behind on payments, you’ll likely be unenrolled from the program.
Credit Score After Bankruptcy versus a Debt Management Plan
DMPs help preserve your credit score, but filing bankruptcy could do damage that lingers for years to come. A DMP does not result in any negative remarks on your credit report. However, your credit utilization could increase if the accounts under the plan are closed and temporarily ding your score until you start to pay down the balances.
Both Chapter 7 and Chapter 13 tank your score by 100 or more points. Chapter 7 sits on your credit report for 10 years, and Chapter 13 stays for seven years from the filing date (assuming you complete the plan) or 10 years.
How Much Will Your Estimate Pay if You File for Bankruptcy versus Enrolling a Debt Management Plan?
Here’s an estimate of how much you can expect to pay if you enroll in a DMP or file bankruptcy:
- Debt Management Plan: Fees vary by the number of accounts enrolled in the plan. Each state also has limits on the fees credit counseling agencies can assess. You’ll typically pay an enrollment fee and monthly fee for each plan.
- Bankruptcy: The average court filing fee is $300 and $500. You’ll also be responsible for attorney fees, ranging from $1,000 to $2,000 for Chapter 7 and $3,000 to $4,000 for Chapter 13.
How Does the Process Differ Between Filing for Bankruptcy versus Completing a Debt Management Plan?
Most DMPs require you to make monthly payments for up to five years. However, the process for Chapter 7 typically only takes four to six months. But if you file Chapter 13, the payment plan will span three to five years.
Is a Debt Management Plan Better Than Bankruptcy?
By enrolling in a DMP, you lower your interest rate, reduce your total payments by up to 50 percent and pay your debt in full in just 36 to 60 months without ruining your credit score. But suppose you’re completely overwhelmed by your unsecured debt, tired of constant collection calls or facing lawsuits from your creditors over unpaid debts. In that case, bankruptcy could be a viable option.
Before making a decision, reach out to a reputable credit counseling agency to discuss your situation. They will assess your financial situation and discuss debt relief options with you. If bankruptcy seems like a good fit, consult with a bankruptcy attorney to learn more about the next steps.
When Is It Best to Enroll in a Debt Management Plan?
It is best to enroll in a DMP when you understand what they entail and have the financial means to make the required monthly payment to the credit counseling agency.
When Is It Best to File for Bankruptcy?
Don’t file for bankruptcy until you’ve received guidance from an attorney and are knowledgeable regarding the potential outcomes and negative consequences for your credit health.
