The 2022 Guide to Debt Management Plans – Chapter 3
Ever wondered how a debt management plan works or how to go about starting one? Here’s all you need to know on one single page from Cashfloat.
- Debt management plans only cover non-priority debt
- Using a debt management plan will reduce your monthly payments to an amount you can afford
- Your credit rating could be affected by a debt management plan
Debt management plans are a debt solution which many people in the UK use to escape from debt by making their payments more manageable. Like all debt solutions, they work better for some people than for others.
In our 2021 guide to debt management plans, Cashfloat.co.uk has put together a comprehensive guide to debt management plans. As a responsible short term loans lender, we like to keep our customers educated and informed so that they can manage their finances effectively. In this article, we will explain the basics of how a debt management plan works.
What is a Debt Management Plan?
A debt management plan (DMP) is an informal agreement that someone who owes money makes with their creditors. If they are struggling to make repayments, under a DMP they will agree to pay back what they owe under conditions which they can meet more easily.
A debt management plan allows you to pay off your debts in a series of instalments and at a reduced rate. They are suitable for people who are struggling to meet the repayment conditions that they originally agreed to when they first borrowed money, but could pay smaller amounts. Monthly payments are reduced and additional charges and interest are often suspended, so that the amount owed does not continue to spiral upwards. A debt management plan can help you to clear your debts in an orderly way and this could help you to avoid being taken to court.
Remember to Seek Advice
Before entering into any kind of debt solution you should always seek impartial and professional advice. Debt management plans aren’t the only solution to debt and it is important that you are choosing the right solution for yourself. As such, you should always seek advice before entering into a DMP. For more information on who to go to for debt advice, go to Chapter 2 of this guide. Debt charities are usually the best people to seek debt advice from and you should be very wary of debt management companies and other profit making businesses who offer debt advice.
Watch this video from StepChange for a clear overview of debt management plans.
How is One Arranged?
Debt management plans are normally only used to pay non-priority debts and they are normally arranged by a third party. This third part acts as an intermediary between a debtor (someone who owes money) and their creditors (people they owe money to). Before arranging a debt management plan, they will help you to make a budget for yourself. They will ascertain how much money you will have left each month after you have paid all of your priority debts and living expenses. If you have enough left over to start a debt management plan, they will then arrange one.
On behalf of the debtor, they will try to negotiate repayment conditions with creditors to levels which the debtor is actually able to meet. This could mean requesting the creditor to suspend additional charges, suspending or reducing interest or following various other courses of action to reduce monthly payments and the total amount of money which will ultimately be paid.
If these negotiations are successful, the debtor then makes one single monthly payment to the DMP provider, who distributes this money fairly amongst the creditors. If they are able to meet the conditions of the DMP, the debtor will be able to clear their debts. Although, it will take them longer to do it than if they made their normal payments, it is a viable solution to debt. DMPs allow both the debtor to clear their debts and the creditor to receive their money.
DMPs are an informal debt solution, which means that they are not legally binding. Not all of your creditors have to agree to it and they can cancel a deal and pursue you for money that you owe, if they wish. However, creditors will often agree to them and the consequences of making a DMP are usually less serious for a debtor than they are with other debt solutions, such as bankruptcy or debt relief orders.
Is It Free?
There are many debt management companies which will charge a fee to set up a debt management plan. However, there are a number of charities in the UK which provide this service for free. The vast majority of people now use free services provided by charities. Later in this series of articles, we will be looking in-depth at what specific UK charities have to offer. It is much better to use a free debt charity to provide a DMP, rather than a fee charging debt management company.
How Long Does A Debt Management Plan Last?
There is no set time for how long a debt management plan lasts. The time it takes to pay off your debts will depend on how much money you owe and how much you can afford to pay each month. While some can be short in duration, many debt management plans last for years. They can be speeded up by increasing the amount that you pay each month. It is important to remember that the time it takes to pay off your debts is not as important as the fact that you are taking control of financial problems which could, otherwise, have a huge detrimental impact on your life.
Are They Legally Binding?
As an informal debt solution, DMPs are not legally binding. This means that you can stop making payments towards them at any time. However, your creditors will still pursue you for the money that you owe if you do this. The fact that they are not legally binding also means that all of your creditors don’t have to agree to the terms of it and could, potentially, back out at any time.
In some cases, a debtor will have creditors who don’t agree to a DMP and still pursue them for money while they are making payments to other creditors who have accepted the DMP. Some creditors may also continue to add interest and charges to your debt, while your DMP is ongoing.
In practice, if you are able to make reasonable payments under a DMP, most creditors will accept the conditions and will allow you to clear your debts with it.
Will it Affect my Credit Rating?
Being on a debt management plan will affect your credit rating. As you will be making lower monthly payments than you originally agreed to, this will be noted on your credit history. Also, your DMP itself may be noted in your credit history as a ‘payment arrangement’. This will be noticed by future lenders.
Is a Debt Management Plan the Right Choice for Me?
If you are considering using a DMP to clear your debts then there are some things you should do first. The most important thing is to work out exactly how much you can pay each month.Make a Budget
In order to work out whether or not you can actually afford to enter into an agreement with your creditors you need to work out a monthly budget. This can be done by working out your monthly income and then calculating your monthly outgoings. Normally, only unsecured debts can be included in a debt management plan. You must make sure that after paying your priority debts and living expenses (making sure that you provide a reasonable standard of living for you and your family) that you have enough money spare to pay towards a DMP.
First, work out what priority payments you have to make, such as for your mortgage, rent, council tax or utility bills. Add onto this how much you spend on living costs each month, such as for food and clothing. After that, calculate how much you spend on other essentials you pay for infrequently, such as car repairs and include these in your monthly budget by adding up the total annual cost and dividing it by 12. It is important that you do not restrict your living expenses so severely that you are unable to provide a reasonable standard of living for you and your family.Can You Contribute Towards One?
Having worked out your income and expenditure, you must deduct one from the other and see how much is left to pay towards your debts. Knowing how much spare money you have available , should give you an indication of whether or not you will be able to arrange a DMP. The best thing to do next is usually to speak to a professional and impartial debt advisor who will be able to advise you as to whether a debt management plan is the right solution for you. It may be that an alternative debt solution is more appropriate for your circumstances. They will be able to advise you if this is the case.
If you can make contributions towards a DMP, but your debts cannot be paid back in a reasonable amount of time then it may not be a good option for you. In this situation a formal agreement, such as a debt relief order, is usually a better option, although these can have a more negative effect on your credit rating.
Benefits of a Debt Management Plan
Apart from the fact that actually tackling your debts will give you some peace of mind, there are other benefits to setting up a debt management plan.
Under a DMP you will only have to make one monthly payment to your DMP provider, rather than to several creditors.
Your debt management plan provider will contact all of your creditors and agree a plan with them on your behalf. This can be a difficult procedure and having it handled by a third party will save you a lot of worry.
Interest and other charges on your debts may be reduced or frozen for the duration of the plan and this helps to prevent debts from continuing to increase.
The organisation that is handling your affairs will take away the need for you to have ongoing contact with your creditors. Although you may still get some correspondence from them, a DMP will usually stop threatening letters and other difficult correspondence.
The debt management plan will reduce your monthly payments to a manageable level. This will allow your life to return to some kind of normality. They are also flexible, meaning that you can vary the amount that you pay.
As they are informal arrangements, you are not tied into an agreement so can leave at any time.
If you do this through a charity it will be totally free and all of your money will go towards paying off your debts.
Of course, one of the biggest benefits of using a debt charity to arrange a DMP is that they are used to this kind of situation and deal with many creditors every year. Their experience will help them to deal with creditors more efficiently and effectively than many people who owe money may be able to do themselves.
Drawbacks Of A Debt Management Plan
The most off putting thing about setting up a debt management plan is that it can take many years to pay off your debts. Under a debt management plan it will take longer to pay off your debts than if you stick to your normal payments. However, it is important to remember that otherwise you would, most likely, fail to make payments and end up in a worse situation. In addition to this:
- Your creditors do not have to stop or reduce interest rates and charges. In some instances, while you will be able to meet monthly payments, this could make the total amount you repay higher.
- Even if your creditors agree to the plan, your credit rating will be affected because you will be making reduced payments towards your debts. The fact that you have arranged a DMP may also be noted in your credit history. This could affect your future borrowing options.
- While it is uncommon, your creditors may still take further action against you to reclaim their money while your DMP is ongoing.
- Unlike some other debt solutions, your debts will not be written off and you will still have to repay them.
- Mortgages and other types of secured debt are not covered by them.
How Do I Arrange a Debt Management Plan?
There are a number of debt charities that will set up a debt management plan for free. You can find brief information on what help they can offer in Chapter 2 of this guide and in depth information about individual charities in Chapter 22. Alternatively, you can search on the internet through one of the many money advice pages. Beware of searching for ‘free debt management plans’ on Google, as some debt management companies advertise their services as ‘free’ when in fact there is a charge.
Before you arrange a debt management plan, you should seek professional and impartial advice, so that you are certain that it is the right solution to your debt problems. Many debt charities will be able to give you debt advice and also to arrange a DMP for you if it is appropriate.
Can You Set Up a Debt Management Plan by Yourself?
The vast majority of people choose to have a DMP arranged on their behalf by a third party provider and, as they can be provided for free, there are few benefits to arranging your own. However, it is possible to arrange your own debt management plan. In order to do so, you will have to organise your own finances, negotiate with your creditors and handle payments to them. For more information on this, go to Chapter 5 of this guide.
What to Consider Before You Start a Debt Management Plan
Before committing yourself to a debt management plan you should look at all the different ways in which debt can be tackled and seek professional and impartial advice. A debt counsellor will be able to advise you on whether a DMP is the right way to go or whether the amount you owe is too small or too large for this option. Don’t embark on a debt management plan until you are sure that this is the right solution to your debts.
If a debt management plan is right for you, it can give you breathing space to get your life back on track and relieve you of the pressure to repay all of your debts at once. Read the rest of this guide to find out more about what happens after you arrange a debt management plan, who the best people are to go to for help and why you should avoid debt management companies.
Who are the Right People to Help You Deal with Debt?
Common Questions about Debt Management Plans