Understanding debt management
It is not unusual to use multiple credit cards as a method of juggling debts alongside other financial commitments such as home improvement loans, car finance or short-term borrowing. However, while affordable debt is not a problem, you may at some point find that you have taken on more financial commitments than you can afford.
Possessing substantial debt could be the result of a change in circumstances such as redundancy, illness or a relationship breakdown, or because your borrowing has become unaffordable due to a change in interest rate or the end of an interest-free period. It may even be that you have been encouraged to take on additional borrowing as a result of unfair or irresponsible lending practices.
Whatever the reason, debt management can be a good tool to help you get back in control and on top of your borrowing again.
What is debt management?
Debt management is an arrangement to share your disposable income between your creditors and pay back your borrowing at a manageable level. Typically, this will be a payment which is less than the minimum payment or contractual commitment to pay your account. Your lender will at least agree to accept this payment until your circumstances improve instead of the payment set out in your agreement.
There are many companies who specialise in setting up debt management plans between you and your creditors. These companies will help you negotiate the payment arrangements with your creditors. Many will also collect the payments from you each month and send the agreed amounts to each of your creditors.
It may help to have one payment to make each month rather than several to your individual creditors. You may also be anxious about negotiating a reduced payment plan with your creditors. In this case, it could be a good idea to use a specialist debt management provider, but the truth is that debt management is something easy that you can do yourself.
Is debt management important?
Debt management is important because it stops the situation escalating and allows you to get back in control of unmanageable debt across multiple companies. Your lenders may agree to freeze interest and charges which will make it easier to pay off the full balance eventually. They may also agree to stop, or at least delay, the account from defaulting, preventing negative reports from being added to your credit file.
It is important to remember that while you are in debt management, your lenders can still sell your accounts to third party debt collectors. This is not something to worry about and will not have a negative affect on your plan or your finances.
Your lender may sell your debt because they realise that it will take them a long time to recover the full value from you and would rather receive a lump sum from a debt collector. Even though this payment could be as little as ten per cent of the outstanding balance, it could still take years for you to pay the same amount back.
Many online sources will tell you that debt management is not a ‘legally binding’ solution. We are not sure what these companies mean by this and it is simply not true.
Unlike other debt solutions such as bankruptcy, a debt relief order or an IVA, debt management is not a formal written agreement that is ratified by the courts and there are no consequences of breaking the agreement. However, refusing to meet the terms could lead to further collection and enforcement action.
If your lender agrees to terms for reduced payment under a debt management plan, whether this is with you directly or through a debt management company, they cannot change their mind without good reason.
The payment that you agree may last for a short period, but it may be sensible to agree to annual reviews. After this time, you and your lender will come together to make sure that you are paying as much as possible without putting too much pressure on your finances. Typically, they will do this by going through a new income and expenditure questionnaire with you. If you can afford more, they may ask you to increase your payments, otherwise your payments will continue or even reduce.
The FCA, the regulator for the financial industry, makes it clear that lenders cannot push you to make payments that you cannot afford. This means that they must allow you money to live and meet priority bills and expenses. Even if you’re in debt management or behind with your monthly payments, you should never feel under pressure to agree to payments which you can’t realistically make.
Is debt management bad for your credit?
Debt management involves making payments which are less than the agreed amounts towards your debt. The fact that you are not making your contractual payments will be reflected on your credit score and is likely to have a negative impact. However, that doesn’t mean that debt management is necessarily bad for your credit, and in fact, it is much better than many other alternatives.
At this point, it is worth saying that credit reporting is not an ‘exact science’ and how lenders assess your credit history will vary significantly depending on the lender and the type of credit you are applying for. Some lenders may have a very detailed look through your credit history before deciding whether to advance credit. Others may just use a computer based ‘scoring’ system to decide whether your credit rating meets a certain threshold. Often, this means that the same borrowing history may count in your favour with some lenders, but against you with others.
To further confuse matters, the credit report that you see on whatever platform you use will not be what your lenders see. To illustrate this point, try looking on one platform and then compare your score on another (e.g. ClearScore against Credit Karma). You may find that the score varies wildly. This means that there is not a yes or no answer to whether debt management is bad for your credit. This will depend on your history to date, your alternatives at this stage and your future borrowing requirements.
When you are in debt management, your credit rating report will reflect that you are not making your minimum payments each month. You will start to fall into contractual arrears on the account, and this is likely to be reflected on your credit report. If the accounts haven’t already been defaulted, then the lenders will likely default the agreement after a period in debt management.
It is possible that your lender will report to credit reference agencies that you are making agreed repayments. But this is only likely to have an impact on your report. If you have had to reduce your monthly payments this will not look good to prospective lenders, although they should perhaps be reassured that you are making a payment.
The truth is that if you cannot keep on top of your financial commitments to borrowing or if you are needing to borrow to meet them, your credit rating is bound to be affected. In our experience, trying to second guess the effect on your credit report is not helpful and will often lead to unsustainable behaviour which is likely to be more damaging in the long run.
The question to ask yourself if is: can you keep up to date with the agreed payments towards your loans, credit cards and other commitments? If the answer is ‘no’, then at some point your accounts will default, or at least report arrears until you are able to increase payments, and your credit report will be affected.
Agreeing a debt management plan sooner rather than later will give you the best chance of maintaining a healthy credit score. You can always ask your creditors to consider not making reports to credit reference agencies or defaulting the account for a period of time. They may be willing to do this, particularly if you only expect to be in difficulty for a short period.
By contrast, if you do not make any payment to these accounts, not only will they default but you might also end up with judgements against you which will be pretty terrible for your credit rating. Alternatively, you may decide to pursue an IVA, bankruptcy or other insolvency solution. These will have a devastating effect on your credit and you will not be able to get further credit, at least while you are insolvent, but likely for another six years from the date of the arrangement.
Is a debt management plan right for me?
A debt management plan is a good way to get back in control of unmanageable debt. Whether this is a plan that you set up yourself or something you do through a debt management company, entering a debt management plan demonstrates to your creditors that you intend to work with this to pay back your debt.
Keeping your creditors on your side is very important if you are experiencing financial difficulty. This is because talking to your creditors stops the situation from escalating and may prevent legal action like issuing a claim against you.
Debt management is a good option for many people with unmanageable debt or credit commitments, particularly if you expect your situation to improve soon. Often debt management will stop interest being added to your account and damaging reports won’t be made to credit reference agencies. You should always speak to your lender before making a decision, as the exact terms of debt management will vary from lender to lender. Debt management will have less of an impact on other areas of your life than insolvency solutions such as bankruptcy or IVA. With these, you have no control over how much you will be required to pay each month and your credit rating will be severely affected.
The major drawback of debt management is that it can take a long time to pay back the full amount and close the accounts. According to statistics published by StepChange, the average duration of a debt management plan was more than 11 years. However, the important thing to remember is that debt management is a great way to get on top of debt and put you in the right mindset to look for help to really escape debt for good.
If you are already in a debt management plan or are considering this debt solution we would be happy to talk to you about debt management and your options. Galahad & Co. has a unique legal solution to debt which has helped many people achieve their goals of debt freedom in just 12 months.