A Comprehensive Guide to Debt Management | Fora Financial Blog
A Comprehensive Guide to Debt Management
July 22, 2020

A Comprehensive Guide to Debt Management

Drowning in personal or business debt (or both) is a threat you can’t ignore. In fact, accumulating too much debt is one of the primary reasons that about half of small businesses fail within one year.

Put simply, when you’re facing serious debt problems, you need to get them under control.

However, as anxious as you may be to start doing something to tackle your debt, it’s best to step back and fully understand debt management before moving forward. There are many options, with various advantages and disadvantages, to consider before you decide what to do.

When you’re finished reading, you’ll know everything you need to get your debt under control as quickly as possible. 

What is Debt Management?

Debt management is a blanket term for everything you (or an outside company) does to reduce the balances on your credit card accounts, loans, and other debts.

This could include activities like negotiating with your credit card company for a reduced interest rate, holding a garage sale, creating a daily budget, or consolidating your loans. In short, you can consider debt management anything that’s done to reduce, reorganize, or eliminate your debt burden.

You can put debt management into action by yourself, with your business partner, or with the help of a trusted advisor. You can also work with a credit counselor and enroll in a debt management plan. Just keep in mind that debt management plans only help with unsecured debt such as credit cards, personal loans, or any other debt that isn’t secured by collateral.

Above all, your spending behavior is the key to successful debt management. While it’s true there are tools you can use to create an easier path out of debt, ultimately, there’s no way around changing your spending habits. You can consolidate debts and negotiate reduced interest, but if you continue spending and using debt irresponsibly, you’ll end up in the same predicament in the future.

calculator and financial planning sheet

What are Debt Management Plans, and Why Are They Important?

You can work with a credit counselor to create a debt management plan (DMP) which is a structured path designed, based on your situation, to eliminate your debts.

Generally, to start a DMP, you’ll attend a counseling session with a credit coach who will ask detailed questions to understand your financial circumstances. Based on your answers, the counselor may suggest options other than—or in addition to—a DMP.
For example, if you have several loans, your counselor may suggest consolidating your debts by rolling them into one loan to simplify your payments and reduce interest charges.

After understanding your goals, your credit counselor will contact creditors on your behalf to negotiate for lower payments or a reduced balance. They’ll also make themselves the payer on your accounts. So, for the length of your plan, you’ll send monthly payments to your credit counselor who pays your creditors directly.

Your credit report will show that your accounts are in a debt management program, but that won’t negatively affect your score. Still, potential lenders will see that you’re in a DMP and that’ll likely make them less willing to lend to you.

The debt management plan will tell you exactly how much you must pay each month to get out of debt. Your payment amount will be determined based upon how much you need to pay to eliminate your debt in a certain period, usually 3 to 5 years.

Whether you enroll in a debt management plan with a credit counselor or you manage your debt yourself, simply having a plan is critical. When you have a plan, it’s easier to avoid making emotional spending decisions. A plan also makes things simple by clearly specifying how much money you can spend each month while staying on track to get out of debt. 

Debt Management for Nonprofits

Whether you run a for-profit or nonprofit business, the problems that excessive debt causes and the solutions to those problems are similar. Of course, as a nonprofit, you have restrictions on how you can raise funding, but you can enroll in a debt management program just like a for-profit business.

If you choose to enroll, the process is generally the same as detailed in the previous section.

Still, you should ensure the counselor you hire takes the time to understand the unique nature of your business and financial situation. For more information on hiring the right company, The Federal Trade Commission (FTC) has this resource on choosing a credit counselor

Pros and Cons of Debt Management Plans

As referenced earlier, debt management plans have their benefits and drawbacks. Some of these may be a big deal for you, but not for another business owner. The important thing is to make sure you’re considering the full scope of a debt management plan’s pros and cons. 

Advantages of Debt Management Plans

With a debt management plan, you simplify your life by enlisting the help of an outside agency to help you create and execute your plan.

The company you hire will evaluate your situation, help you create a plan, deal with your creditors, educate you about debt management, and provide you with various debt relief options to choose from. You’ll pay one monthly payment to them and they’ll use that money to pay your creditors which reduces your administrative burden.

By clearly specifying how much you need to pay each month to get out of debt, it’ll be easier to understand exactly how to budget for your business expenses. You’ll quickly start to realize which expenses and spending habits you need to eliminate or reduce to resolve your debt problem.

Also, by creating a debt management plan with an outside agency, you essentially outsource the management of your debts to someone else.

Of course, it’s still critical for you to play your part by making timely payments, but a debt management plan will take a lot of administrative work off your hands. You’ll even stop receiving—or receive fewer—annoying calls from your creditors which will help you focus on your business.

Just as important as outsourcing debt management tasks, a high-quality credit counselor will also help set you up for long-term success through education.

You’ll learn and improve your financial discipline by learning how to make a budget, track your spending, and avoid unnecessary expenses. This will put you ahead of your competitors. 

As David Worrell, a consulting CFO and author says, “So many businesses simply do not have the financial discipline to work through a crisis and come out bigger and better.”

By going through a multi-year debt management plan, you’ll come out “bigger and better,” and ready to handle any financial curve balls thrown your way.

Disadvantages of Debt Management Plans

To be clear, there’s nothing bad about managing your debt; every business owner should be doing it whether they’re in trouble with debt or not.

However, there are some drawbacks to enrolling in a debt management program with an outside agency. One of the primary disadvantages is that you’ll have to pay a monthly fee as well as an enrollment fee when you sign up. These fees eat away at the savings you get from the lower monthly payments generally associated with debt management plans.

In addition, when you enroll in a debt management plan, your credit card providers will usually require that you close your accounts. That means you won’t be able to use your credit cards for the duration of your debt management plan. For some business owners, this can be a major hassle, but for others, it can be a great way to get their spending under control.

credit cards and lock

Another disadvantage of debt management plans is that they can’t help you with secured debts. Therefore, if you’re having trouble with your car and/or house payments, a debt management plan won’t help you. Of course, if you’re having problems with both secured and unsecured debts, you can use the DMP to help with the unsecured portion of your debt. 

Important Things to Know – Debt Management for Small Businesses

There’s an entire industry built on debt management solutions. Debt management plans are just one of many viable paths out of debt.

To decide on what the best move for you is, there are several important things to know. This includes debt management alternatives to avoid, impact on your credit score, and the difference between bankruptcy and debt management. In this section, we’ll cover all that and more. 

Debt Management Alternatives to Avoid

What you should avoid depends in part on your situation. For example, if you’re deep in debt, but haven’t tried cutting back on expenses or negotiating with your creditors, you shouldn’t jump to filing for bankruptcy.

If there’s even a possibility that you can get out of debt with another method, you should avoid bankruptcy because it will significantly impact your credit for 7 to 10 years.

Similarly, if you have no money to make payments, you shouldn’t enroll in a debt management plan. There’s no use committing to several months of payments that you know you’re not going to make.

Ultimately, you can make better choices about managing your debt based on your circumstances when you understand your options. To that end, we’ll outline a few debt management alternatives in the next three sections.

Debt Consolidation

When you consolidate debt, you have two main options:

  1.   Use the proceeds from a low-interest debt consolidation loan to pay your debts, then make payments on that loan.
  2.   Transfer your debts to a zero-percent interest, balance-transfer card and pay those debts back during the card’s promotional period.

Neither option works for everyone. If you have bad credit, it’ll be difficult to qualify for a zero-percent interest card or low-interest debt consolidation loan. In some cases, even if you can qualify for a debt consolidation loan, the rate may not be low enough to justify consolidating your debts.

In addition, debt consolidation won’t do you any good if you don’t also have a plan to consistently make your payments and keep your expenses low.

All that said, if your credit is good enough to qualify for a low-interest loan or zero-percent credit card, and you have a detailed plan to stay on track, debt consolidation can be a great tool.

Not only will it simplify your finances, but you’ll also have a clear end goal in sight since your consolidation loan will have an end date, assuming you stay current on your payments. Plus, depending on your situation, debt consolidation can save you a significant amount of money in interest.

Debt Settlements

Debt settlement is when a debtor (or their representative) negotiates with a creditor to accept a lower payment than the debtor owes as full payment. Simply put, it’s a way to resolve debt with a smaller payment than what you owe.

It sounds too good to be true, and usually, it is. Debt settlement is risky and NerdWallet considers it “a last resort.”

For starters, you can only settle a debt once you’re well behind on your payments. After all, no creditor will settle for less when they think there’s a chance you’ll pay what you owe.

That means, to have any chance of settling your debt, you’ll have to stop making payments. Debt settlement companies will have you put your monthly payments in a savings account until they think there’s a chance you can make a successful settlement offer.

Doing that will destroy your credit, and even then, there’s no guarantee your creditor will settle the debt. All the while, you’ll be racking up penalty fees, late charges, and interest, so if debt settlement fails, things go from bad to worse quickly.  

Finally, even if your debt is settled, you may be taxed on the amount of debt that was forgiven and you’ll pay a fee to your debt settlement company. Like we said, debt settlement is a last resort.

About Dave Ramsey’s Snowball Method

If you decide to manage your debt on your own, Dave Ramsey’s Snowball Method is one way to do it.

snowball effect

According to Ramsey’s website, this method is “a debt reduction strategy where you pay off debt in order of smallest to largest, gaining momentum as you knock out each balance.” 

As you focus on paying as much as possible on your first, smallest balance, you make minimum payments on all your other debts. When you pay off your smallest balance, you start focusing on the next smallest balance, and so on.

For example, let’s say you have a personal loan with a $1000 balance, a credit card with a $5000 balance, and a $10,000 student loan. Regardless of the interest rates, with the snowball method, you’d make minimum payments on your credit card and student loan while you pour any available money into paying off your personal loan.

Once the personal loan is paid off, you’ll have fewer bills to pay which will free up more of your money to tackle the bigger debts.

The idea here is to build momentum as you knock one debt out after the other. Momentum is critical in successful debt management because getting out of debt is an emotionally draining process.

However, when you see your balances start to disappear, you get small wins, which motivates you to keep going. On the other hand, if you start with a $10,000 student loan, it’ll take a long time to pay it off, which can kill your motivation.

Does Debt Management Affect Credit Scores?

The short answer is, it depends.

Debt management can make your credit score much better or much worse depending on if you make your payments. In the short-term, enrolling in a debt management plan won’t hurt your credit but it will be a red flag to lenders. If debt consolidation is part of your debt management program, your score will generally drop a few points because it requires a hard inquiry.

However, when it comes to debt management, it’s the long-term effect on your credit that matters. In the long-term, successful debt management—which means you’re making payments on-time and in full—will always improve your credit score. 

What is the Difference Between Bankruptcy and Debt Management?

Bankruptcy is a legal process by which an individual can reduce or discharge their secured and/or unsecured debts with some limitations. In Chapter 7 bankruptcy, the debtor will be forced to sell all their nonexempt property to discharge their debts. In Chapter 11 or 13, the debtor enters a court-approved debt repayment plan.

Unlike debt management, bankruptcy is a formal legal process that takes place in court. In addition, you can use bankruptcy to discharge certain secured debts, which is not possible with debt management. Moreover, whereas debt management doesn’t directly affect your credit, a bankruptcy stays on your credit report for 7 to 10 years.

Finally, with debt management, you have a fair amount of flexibility as to how you want to handle your debts. When you file bankruptcy, though, you’ll be forced to abide by whatever course of action the court orders.

Debt Management in Small Business Financing

Successfully financing your business is fundamental to your success. However, as shown by ballooning consumer debt and the 2008 financial crisis, it’s easy to go overboard if you aren’t careful.

Still, because debt is such a potent tool for growing your business, you can’t afford to ignore it. That’s what makes debt management so important. When you responsibly manage your debt, you reap the rewards of raising capital while insulating yourself from the downside of falling behind on payments. In short, debt management can give you the best of both worlds.

Of course, if you’re already behind on payments, the last thing you should do is take on more debt. Instead, explore your alternatives, consider your situation, and look to create a path out of debt for yourself. That path might include a debt management plan, or it might include a stricter business budget.

However you choose to manage your debt, the most important thing is to educate yourself, create a detailed plan, track your progress, and adjust when necessary. From there, even if you make mistakes, you’ll have the information you need to rectify them quickly.

Finally, even after you’ve pulled yourself out of debt, keep making responsible debt management a core part of your business strategy. For help with that, sign up to our email list to get the latest business tips about debt management delivered to your inbox.

Editor’s Note: This post was updated for accuracy and comprehensiveness in July 2020.

Fora Financial

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

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Fora Financial is a working capital provider to small business owners nationwide. In addition, the Fora Financial team provides educational information to the small business community through their blog, which covers topics such as business financing, marketing, technology, and much more. If you’d like to see a topic covered on the Fora Financial blog, or want to submit a guest post, please email us at [email protected].