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What are the advantages of a Debt Management Plan?
A Debt Management Plan (or DMP) is an informal agreement with creditors reducing the monthly repayments that they accept so that these fit within an affordable budget. With the significant increase in the number of IVA applications over the past 2-3 years, Creditors seem more and more keen for people to use a DMP to resolve their debt problems. I have seen a number of creditors hard sell the DMP solution suggesting that it is far better for the individual than an IVA. However, who’s best interests do the creditors have at heart?
When looking at a DMP it is essential to consider not just the short term gain but the long term result. If used properly, it is true that a Debt Management Plan will get immediate debt payment problems under control and bring an end to robbing Peter to pay Paul. However, the DMP will often not ultimately resolve the debt problem.
The main issue lies in the fact that if you use a DMP, you are still obliged to pay back 100% of the debt that you owe. Clearly with reduced monthly payments, the time it will take to repay back what you have borrowed will be significantly extended. Simply dividing the total amount of debt you owe by the total monthly payment agreed in a debt management plan will give you the number of monthly payments you will have to make. In many cases this will be over 8-10 years.
Scrimping, saving and living within a tight budget to repay your debts is not easy. It is difficult enough facing this for 5 years in an IVA, however, if you are looking down the 10 year path of a Debt Management Plan, this prospect just does not offer any light at the end of the tunnel. With human nature being what it is, if we can not see progress, we are likely to give up. This is why that majority of Debt Management plans fail after their 1st or second years.
But if they have such a high rate of failure, why are the banks in favour of Debt Management Plans? One school of thought is that banks are allowed to treat Debt Management Plans more favourably when considering bad debt provisioning on their balance sheet where as debts within an IVA must be written off 100%. If this is the case, then there is a clear corporate benefit from pushing people down the DMP route and steering them clear of an IVA. But surely, what is needed here is a solution which is ultimately going to resolve an individual’s debt problem rather than one which seems to serve the creditors best interest of showing higher profits?
Compared to an IVA, a Debt Management Plan is relatively easy to put in place. Basically you work out what you can afford to pay each month to all of your creditors and then divide this equally between them on a pro rata basis. These reduced amounts are then offered to the creditors. Once accepted as reasonable, this situation gives immediate relief from your creditors as suddenly you are making regular monthly payments to them based on what you can afford - no more robbing Peter to pay Paul.
If you are a home owner, a Debt Management Plan will normally not force you to consider releasing any equity from your house. In addition, the agreement is informal. As such, it is not a legal requirement to include all of your creditors. As such, you could undertake a Debt Management Plan with most of your creditors but leave perhaps a credit card out and continue using that as normal (although this practise is not recommended).
There are of course some downsides to the Debt Management Plan which should be considered. Firstly, with a DMP, you may be repaying what you owe at an easier and reduced rate. However, you still have to pay everything back. Normally this will take a considerable time - 8-10 years on average. It’s a long time to be living within a tight budget will little light at the end of the tunnel.
Secondly, creditors who agree to a DMP are under no legal obligation to freeze their interest and charges. They may agree to do so for a certain time or may use the threat of continuing to add interest if you do not agree to pay them more each month than you can reasonable afford.
Thirdly, because the Debt Management Plan is not legally binding, creditors can demand increases in monthly payments at any time. If one of your creditors suddenly decides that your reduced monthly payment is no longer acceptable they can demand that you pay more. This means that DMPs are uncertain and you never know quite where you stand.
In summary, a Debt Management Plan can be an excellent tool for resolving a debt problem. However, there are some significant pitfalls and disadvantages which you should also be fully aware of.
About the Author
Steve Jackson, Author for BeatMyDebt. For more information related to Debt Management Plan visit ,http://www.beatmydebt.com