Q: What is debt management, debt settlement and debt consolidation, and which is best?

A:. Debt management is really just the act of budgeting so that you control and pay off debt. This is self-management and a very positive thing. It has no negative impacts.

A debt management plan (DMP) is a program provided by a credit counseling agency to make it possible for a distressed borrower to pay off debt by means of assistance and concessions from lenders. This is a necessary activity for some borrowers who otherwise might need to seek bankruptcy. A DMP does entail closing accounts and dealing with notations on the credit report, but it is certainly less harmful to credit ratings than bankruptcy. Some folks actually see their credit scores improve during a debt management plan if they had a very poor record but you wouldn’t do it to improve your credit rating and it would impact your ability to obtain new credit for some period.

Debt consolidation is the act of taking out a loan in order to pay off other loans. Recently, many borrowers have taken out home equity loans in order to consolidate their unsecured debt into one payment with a lower APR or interest rate. Consolidation can make sense financially in that a borrower may get a lower interest rate. In general however, the idea of borrowing one’s way out of debt is dangerous and it is risky to turn unsecured debt, like credit card debt, into secured debt, like a mortgage. Too many consumers continue to use the credit cards and when they cannot make their payments, many lose their homes.

Many people refer to a debt management plan as debt consolidation, but the only thing that gets consolidated with a DMP is the payment. There is no new credit involved in a DMP and loans are paid off as funds become available.

Debt settlement is the process of offering creditors part of the amount owed (typically 40 or 50%) as payment in full. There are attorneys and companies who specialize in this activity but you can also do it yourself.

When a debt settlement company does this, they have you send them money. They inform your creditors that you will not be paying your credit card bills and they offer to settle for part of the amount owed. Of course, the agent charges a fee for this service. In addition, any amounts forgiven over $600 are taxable. Moreover, the creditors have no obligation to accept these offers. You will be contacted by collectors and any given creditor may decide to take legal action rather than settle. Consumers have had their wages garnished while waiting for settlements. Creditors are usually fairly efficient at determining if a borrower has the capacity to repay a debt.

If you do settlement yourself, you need to employ the same strategy. You would call your creditors, inform them that you are unable to pay your debts in full and offer a reduced amount as payment in full. Ask them to send written confirmation of their acceptance of your terms before sending any payment. And again, they do not have to accept your offer.

Debt settlement is an extreme option, but it does sometimes work and if your choice is between a Chapter 13 bankruptcy and debt settlement, it may be worth considering settlement. Don’t expect to save more than 25% of the amount owed after fees and taxes are taken into account and expect your credit record to be severely tarnished for many years.

You should at least consider bankruptcy as an option if your situation is serious enough to contemplate debt settlement or if you are on the verge of losing your home or vehicle. If your income is low enough to qualify for a Chapter 7 filing, you might be absolved of some or all credit card debt for less cost. Either program ruins your credit rating, so if these are your only options, do the one that saves you the most money. See an attorney for details.

So, which is best? A DMP is safest in terms of risk to your credit and financial stability than the other options, but still has costs. A consolidation loan keeps a consumer more independent and more in control but entails the risk of more debt and the temptation to charge more. An extremely disciplined person who has debt issues only due to an illness or unforeseen problem might do better with consolidation than a DMP. Someone who has trouble controlling spending and budgeting will almost always do better with a DMP. A DMP requires a long-term commitment, but a consolidation loan or debt settlement program will also likely involve payments for years. Only a Chapter 7 bankruptcy can be finalized in a reasonably brief period of time.

As with most decisions in life, there is not a correct decision that applies in every circumstance. Think about your choices carefully and make the one that is best for you.