What you need to know about debt management plans

By Jemma Porter

The world is a difficult place to live in at the moment, jobs are being lost and unemployment figures rising, personal debt is increasing and energy bills soaring. The outlook looks bleak for most people, let alone those individuals burdened with debt.

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UK debt statistics from Credit Action say the average household debt, including mortgages, stands at £55,808 (as of December 2011). Excluding mortgage debt, the average household has £7984 hanging over its head. In addition, £174m in interest is paid every single day by UK consumers.

In the majority of cases, debt is not caused by individuals being careless with their finances, but is usually down to a change in personal circumstances such as job loss, separation from a partner and other life changing events.

There may become a point when it is far too difficult for one person to handle the debt themselves due to the constant letters and phone calls reminding them of money they owe. Debt can become a vicious cycle as payments simply go towards paying interest and penalty fees rather than the original balance.

In such cases, a debt management plan (DMP) from a legitimate organisation could help provide some relief and put individuals back in control of their own finances. With so many television adverts from debt companies claiming to be able to solve problems in a jiffy, it can be difficult to know which one could actually help.

Finding a suitable DMP service
If you're in that position, start by carrying out a little research. So many debt companies advertise online, on television and put leaflets through doors, but finding a company that actually could help out -- and for little or no cost -- can be a struggle. Many debt companies charge extortionate fees for debt consolidation and debt management plans, but there are charities that provide these services for free.

Good places to start are recognised companies such as the Consumer Credit Counselling Service, Payplan and National Debtline. Any DMP service you work with should be licensed by the Office of Fair Trading (OFT).

Any DMP service you work with should be licensed by the Office of Fair Trading (OFT).      

How does a debt management strategy work?
A debt management plan is an agreement between an individual and their creditors to make one, consistent monthly payment to the debt management company or charity, rather than paying each lender individually.

The fixed monthly payment is based on the individual's budget and will be an agreed-upon, affordable amount. The payment will be split by the debt company between and the creditors each month. The companies may agree to freeze interest charges but they are not obliged to do this.

If you have opted to work with a debt company that charges a fee for the DMP, this charge will be deducted from the monthly payment before it is distributed.

Who is a DMP suitable for?
Debt management plans are not suitable for everyone, as by setting up a DMP you are agreeing to repay your debts in full. This means that individuals need to have some money left over after paying all household bills and other essential expenses every month.

If you're considering a DMP, you should draw up a budget that outlines your monthly income and expenses. If there is only a small amount left over after paying bills, alternative methods of repaying debt should be sought.

Will a DMP affect my credit report?
Debt management plans do not show on your credit report or affect your credit rating directly. However, your credit rating may be affected as a result of a DMP because you will not be paying the repayment amount that was originally set up with the creditor. The benefit of having a DMP is that the monthly payment may help reduce the original debt amount much faster than if dealt with by yourself.

Will I be able to get credit in the future?
If you have used a DMP for debt consolidation you should be able to obtain credit in the future, depending on your credit rating. However, it can be considered fraud to try and obtain credit whilst in a DMP as you would be theoretically taking out credit that you are fully aware cannot be repaid.

See related: How to rebuild your financial life after bankruptcy

Published: 8 December 2011