Debt Management Plans: Is a DMP Right for me?
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When financial trouble hits, debt can pile up quickly. Fortunately, nonprofit credit counseling agencies offer repayment plans that can help people get back on track — even those with tens of thousands of dollars in credit card debt.
If you're looking for debt help, it's important to know how to identify legitimate resources and be on the lookout for potential scams. The National Foundation for Credit Counseling (NFCC) is a great place to start looking for assistance. If you find yourself falling behind, a certified credit counselor can help you determine whether you can tackle your financial challenges through budgeting and reduced spending or through a debt management plan, also known as a debt management program or DMP.
A DMP is a monthly repayment plan to help consumers pay down their outstanding debt. For a small monthly fee, you can make a single payment to the credit counseling agency, which acts like a trustee in distributing the funds to your individual creditors.
For example, credit counseling agencies work with both individuals and their creditors to design a DMP that lowers monthly payments, interest rates and related fees. This enables consumers to repay their entire debt at more favorable terms that fit within their budget.
Like many long-term plans, a DMP takes time to be effective. The repayment period varies based on the amount owed and the terms, but for most people the plan is structured to repay debt in 36 to 60 months. Consumers who enroll in a DMP may also see interest rates on their credit cards drop, which results in lower payments that may help cardholders repay their balances.
How do I know if a debt management plan is right for me?
Not everyone will qualify for a DMP. After all, creditors are interested in receiving their full payment, so they must be convinced that an individual can no longer make regular payments according to the original credit terms.
How do you know if you may be a candidate for such a plan? Consider these warning signs:
- You are using credit cards to cover daily living expenses.
- You are making minimum payments on credit cards or struggling to make even the minimum payments.
- You are carrying multiple credit cards and rotating their use to juggle balances and due dates.
- You are making late payments or missing payments for more than one month.
- You are charging more each month on your credit cards than you are paying toward the balances.
- You have credit cards that are close to or at their limits.
- You don't know how much you owe.
- You are receiving collection calls from creditors.
Should I use my retirement savings to pay off debt rather than pursuing a DMP?
For some people who face significant debt but have a sizable retirement fund socked away, it may be tempting to skip a DMP and instead use their retirement savings to pay down the debt. After all, if you have a sizable chunk of money sitting untouched, why not use it to become debt-free?
In reality, however, pulling from your retirement accounts, even for a beneficial financial reason such as paying off debt, is likely to cause you more harm than good in the long run and cost you a lot of money. There are few downsides to consider:
- There are considerable tax implications for withdrawing money early from your accounts. If the money comes from an IRA, a 401(k) or a similar tax-deferred retirement account, you will owe income taxes on the money withdrawn. If you withdraw $10,000 and are in the 25 percent income tax bracket, you will incur a tax liability of $2,500. In other words, if you need to net $10,000, you'll have to withdraw $13,333.
- You may face an income tax penalty. If you are younger than 59 ½, you will owe a tax penalty of 10 percent on top of any normal income tax liability for an early withdrawal from a tax-deferred retirement account. That $10,000 withdrawal would now cost you $3,500. There are a few exceptions to this rule. A 401(k) plan is required to allow participants to take a hardship withdrawal. Although you generally do not have to repay the debts, these distributions are fully taxed and subject to applicable penalties.
- You'll be behind in your retirement savings. You might have good intentions and say to yourself that once the debts are paid off, you'll have extra money with which to rebuild your retirement savings. Although some folks will be able to stick to that plan, most will find another use for the money. Further, if a job loss or compensation reduction contributed to your financial woes, this can be even harder to do.
When it comes to living with a substantial amount of debt, ignoring the problem won't make it go away, so get help at the first sign of trouble. Acting quickly to remedy your situation and knowing how to avoid financial missteps in the first place can make the difference between a short-term financial setback and a financial disaster.