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Debt Management Plans versus Debt Consolidation Loans – Which is Best for Me?

The cost of living crisis has meant that more people are struggling to make ends meet.

For many households, monthly outgoings are more than the money coming in, and to bridge the gap, many people are having to rely on credit.

But using credit cards, loans and store cards in this way is not sustainable when you’re already having trouble balancing the household budget.

Sooner or later, the balances start to build up, the monthly payments become a challenge, and the debt becomes a problem.

When it comes to paying off problem debt, two options that people often look at are debt management plans and debt consolidation loans.

Both options are suitable solutions for dealing with debt, but both work in different ways.

In this blog, we’ll explain how a debt management plan is different from debt consolidation and look at the positives and negatives of each one.

1. What is a debt management plan?

A debt management plan, or DMP, is an arrangement to pay off your debts at a rate you can afford by reducing your monthly payments. This arrangement is made with your creditors on your behalf by a third party –  a debt management company or debt charity like StepChange.

2. How do I get a DMP?

You can apply for a DMP by getting in touch with a debt management company or debt charity.

You will speak to one of their debt advisers, who will talk to you about your current debts, your income, your outgoings and your general domestic and financial situation. The debt adviser will go into a lot of detail about your debts – how much you owe, who your creditors are, and what effect the debt is having on your quality of life.

The purpose of these questions is to help the debt adviser gather enough information about your circumstances to be able to give you with the right advice.

As part of the process, the debt adviser will go through your income and outgoings to draw up a budget, so they can establish how much you could comfortably and realistically afford to pay towards your debts each month.

Once you have come to a figure that you are both happy with, the debt adviser will contact your creditors and put forward the proposal. They will also ask the creditors to suspend any interest and charges.

If the creditors accept, the debt adviser will set up the DMP, and you’ll start paying the agreed amount each month. Your payment will go directly to the debt management company or charity, who will then arrange for the money to be shared out to your creditors.

3. What happens with my creditors?

One thing to remember about a DMP is that your creditors are under no obligation to agree to taking reduced payments.

It is also possible for your creditors to take further legal action against you, such as registering a County Court Judgement (CCJ), or involving a debt collection agency to recover what you owe.

However, although this is possible, it is unlikely. Most creditors would prefer to be paid back, even at a reduced rate.

And creditors are expected by the financial regulators to treat their customers fairly and come to reasonable arrangements with people who are struggling to pay back their debts. So, in general, it is likely that a DMP will be accepted by most creditors.

When setting up your DMP, your debt adviser will ask your creditor to freeze any interest and charges. In the majority of cases, they will do this – but they are under no obligation to do so.

Most creditors will reduce contact with you once your DMP is in place, contacting the debt management company or charity directly. However, they might still get in touch at times, especially when your annual review is due (we’ll cover what an annual review is below). A debt management company or charity cannot stop a creditor from contacting you.

Your debt to your creditors will remain until the DMP is completed and your debts have been paid off in full.

Most DMPs last for between 5 and 10 years, but could be shorter or longer, depending on how much debt you have and how much you can pay back every month.

4. How much will I have to pay?

The amount you will pay each month will depend on the budget you and your debt adviser have agreed. This amount will depend on your individual situation. The budget drawn up will make sure that you can cover your priority bills and daily living costs and still be able to pay back your debts in an affordable way.

Each year, the debt management company or charity will get in touch to carry out an annual review. This is to make sure that the amount you are paying is still affordable and to see if you are able to increase your payments, so you can pay the debt back quicker.

You can’t be forced to increase your payments, but you will be encouraged to do so if your situation has improved, as it’s in your best interests to pay off your debts more quickly if possible.

5. What are the positives of a DMP?

  • You can pay off your debts with one affordable monthly payment. Because there is one monthly payment, it can make things easier to manage and less confusing than multiple payments at different times of the month.
  • As you are making reduced payments, this will reduce your monthly outgoings, leaving you with more money left over each month and giving you some breathing space.
  • DMPs are flexible arrangements and can be adjusted to suit your needs. You can exit the agreement at any time.
  • Interest and charges can be frozen, providing your creditors agree.
  • If you use a debt charity like StepChange, the DMP is free, with no set up fees or charges.
  • If you are struggling with debt, then setting up a DMP can prevent the situation from getting worse. Your creditors are less likely to take further action if you are making a reasonable effort to pay your debts.
  • Contact from your creditors can be reduced, which can take away the stress that receiving letters and phone calls about the debt can bring.

6. What are the negatives of a DMP?

  • Your credit profile will be affected by a DMP. As you are paying a reduced amount to your debts, this will be recorded on your credit file, usually as an arrangement. It is also possible that your accounts will default at some point during the DMP. Your creditors could also add a marker to your credit file to show that your payments are being made through a DMP.
  • A DMP will affect your access to mortgage deals. The majority of high street lenders will consider you to be too much of a risk for their best deals. That’s not to say you won’t be able to get a mortgage or a re-mortgage – but the best rates won’t be available, and you might have to go to a specialist lender.
  • A DMP will limit your access to further credit. It’s never a good idea to take out further credit if you’re already struggling to pay back what you owe, and taking out further credit might even breach the conditions of your DMP. If you do apply for further credit, potential lenders will see that you have a DMP when checking your credit file and could either refuse credit or only offer it at higher rates.
  • Not all debts can be included in a DMP. For example, a CCJ would be seen as a priority debt that would have to be paid outside of the DMP agreement.
  • Annual reviews will take place every year during your DMP. If your financial situation has improved, you will be asked to increase your payments, so the debt can be paid off quicker.
  • Your creditors are under no obligation to agree to the DMP.
  • Your creditors are under no obligation to freeze interest and charges.
  • Your creditors could still take further legal action against you, such as court action or involving a debt collection agency.
  • Your creditors might still contact you.

7. What is debt consolidation?

Debt consolidation is where you take out a loan that is secured against your property and use the proceeds to pay off your debts in full. Your creditors are paid off immediately, leaving you with a new loan agreement to pay back.

Debt consolidation loans are also sometimes called secured loans, second charge loans or second charge mortgages.

8. How do I get a debt consolidation loan?

You can get a debt consolidation loan by speaking to a mortgage broker. You can only have a debt consolidation loan if you are a home owner.

You will speak to a qualified mortgage adviser, and the process is just like a normal mortgage application. The mortgage adviser will ask you questions about your employment, income, your current home, your outgoings, and your debts.

Similar to a debt adviser, your mortgage adviser will ask for details about your debts – how much you owe, to who, and how the debt built up. These questions help the mortgage adviser to understand your situation so they can give you the right advice, and also allow them to gather enough information to pass on to the lender, should they need further detail about your debts.

Your mortgage adviser will ask you about your objectives and what you want to achieve with the debt consolidation loan. For many people, one of their main aims is to reduce their monthly outgoings to an affordable level.

Your mortgage adviser will discuss what sort of monthly reduction you would like, and how much money you would ideally want left over at the end of the month, after all of your priority bills and daily living costs (including the cost of the new debt consolidation loan) have been paid.

Once the application is complete, your mortgage adviser will go away and search for the best deal for you, just as they would any other mortgage. If they are a whole of market broker, they will have a wide range of lenders available.

Once they have found a debt consolidation loan for you, they will get in touch and talk you through the features of the new loan before going ahead.

9. What happens with my creditors?

With a debt consolidation loan, your creditors are separate from the application. Unlike a DMP, your creditors do not have to agree to you having a debt consolidation loan. The decision to give you a debt consolidation loan rests entirely with the new lender.

When you take out a debt consolidation loan, the proceeds of the loan are used to pay your debts off in full. The debts to your creditors are then marked on your credit file as “settled.” You will have no further contact with the creditors after that, as the debt has been paid off.

Your mortgage adviser’s case management team might contact your creditors to get up to date redemption figures from them, as a lot of lenders will pay off your creditors directly via bank transfer. Creditors rarely have a problem in providing this information, as they know the debt is going to be repaid in full.

Once the debt consolidation loan completes, and your creditors have received their money, your debt and your obligation to them is complete.

10. How much will I have to pay?

The amount you pay each month will depend on what you discussed with your mortgage adviser, how much money you borrow, and how long you borrow it for.

The longer the term of the debt consolidation loan, the cheaper the monthly payments will be – but longer terms do mean that you will pay back more interest overall. Debt consolidation loans can be taken out from anything between 3 and 30 years.

Just like mortgages, fixed rate products are available for debt consolidation loans. You can fix a debt consolidation loan for 2, 3 and 5 years – meaning that your monthly payment will not change until it reverts to the lender’s standard variable rate at the end of your fixed term.

There are no annual reviews with a debt consolidation loan. You simply pay off the loan throughout the term, according to your payment schedule.

11. What are the positives of a debt consolidation loan?

  • You can pay off your debts with one affordable monthly payment, making it easier to budget and simplifying your finances.
  • Debt consolidation loans can reduce your monthly outgoings significantly, leaving you with more money left over at the end of the month.
  • You can pay off almost any kind of debt with a debt consolidation loan – including CCJs, tax bills and divorce settlements.
  • The debts to your creditors are paid off immediately and in full. Your debts are marked as settled, and you don’t have to worry about any further contact with your creditors.
  • You can have fixed rate debt consolidation loans, meaning that your monthly payments won’t change during the fixed rate period.
  • A debt consolidation loan will show on your credit file, but it doesn’t have the same negative impact that a DMP can have (providing that you maintain your monthly payments.) A debt consolidation loan is marked on your credit file as a secured loan and there is no specific mention that you used it to pay off debts (although a lender who reviews your credit file will be able to work that out, based the date of the secured loan and the dates that other items of credit were marked as “settled.”)
  • Having a debt consolidation loan does not impact on your ability to access favourable mortgage deals, providing that you have no adverse credit, you have a suitable amount of equity in the property, and that the lender’s affordability requirements are met.
  • Having a debt consolidation loan does not affect your ability to access further credit (although it’s not a good idea to take out more credit after paying it off with a secured loan).
  • You can refinance a debt consolidation loan. This is especially useful if you’ve had some adverse credit and have taken out a debt consolidation loan at a comparatively high rate. It might be possible to refinance it onto a better rate in the future, or even combine it with a re-mortgage.

12. What are the negatives of a debt consolidation loan?

  • A debt consolidation loan is secured against your property, so your home is at risk if you don’t keep up with the repayments.
  • A debt consolidation loan will use up some of your available equity. This might affect your ability to get certain re-mortgage deals in the future.
  • Depending on the term of the debt consolidation loan, you could increase the length of time to repay the debt and could end up paying back more interest overall.
  • If you have had bad credit (defaults or CCJs) debt consolidation loans can have higher rates than regular mortgages (although the rates are still often much cheaper than most credit cards and personal loans).
  • There will usually be fees and charges to pay to your mortgage broker and the lender for setting up the debt consolidation loan.

13. Debt managment plan or debt consolidation loan – which is best for me?

The simple answer is – it depends.

The right solution for you will depend on your personal circumstances, your objectives and what is important to you.

If you want to pay back your debts over a period of time in a more affordable way, and are not concerned about the negative impact that a DMP can have on your credit profile, then a DMP might be right option for you.

If you are a home owner whose credit score is important to them, and who wants to pay off their debts immediately, then a debt consolidation loan might be the better option.

Whatever your preference, it’s always best to speak to a qualified adviser.

14. Speak to Dragon Finance.

If you’re having problems with debt and thinking about taking out a debt consolidation loan, give us a call and speak to one of our whole of market mortgage advisers.

We’ll make sure you get the right advice and with access to a wide range of banks, building societies and specialist lenders, we can find the best deal for you.