Debt management plans explained
Debt management companies have been in the news recently after the BBC discovered that unscrupulous debt management companies are holding on to clients' cash rather than paying it to creditors.
This follows the recent comment by the chief executive of the Money Advice Trust charity that some companies were "not in a fit shape to be trusted" following the recent OFT investigation.
All of this means that, more than ever, the UK's indebted families need to know who they should go to for advice, if a debt management plan can help and whether there is a way out of a desperate financial situation.
A debt management plan (DMP) is an agreement between a debtor and creditors when usual contractual payments cannot be made due to financial difficulties.
Originally an American idea, the DMP was introduced into the UK by the Consumer Credit Counselling Service (CCCS) in the early 1990s when the charity was set up. It was a debt solution that dealt with the fallout of unsecured lending in an era when the personal credit market was expanding dramatically.
A DMP provides a structured arrangement to pay off all unsecured debts, rather than writing off some of the money as happens with formal debt solutions like an Individual Voluntary Arrangement (IVA).
This arrangement runs over a longer time period than originally agreed, with one payment per month that the debtor can afford given their circumstances. The payment is distributed to creditors on a pro-rata basis.
Importantly, a well-managed plan provides breathing space. It ensures the debtor has money to afford everyday essentials, rather than feeling pressured to pay creditors their money first.
However there are disadvantages. A DMP is an informal solution, so creditors do not have to accept the plan - although the vast majority do - and a few do not freeze interest or fees, meaning that the debtor continues to be charged.
One creditor disagreeing with the implementation of a DMP will not bring down the plan, but will make it harder for the debtor to pay off all of their debts successfully. In these extreme cases the debt is still paid at the lower pro-rata rate while we - credit counsellors - petition the non-participating creditor to accept the plan.
A DMP not a catch-all either. Depending on the person's situation and the amount of debt, a legally-binding agreement may be a better solution.
For example, we advise our clients that a DMP is not worthwhile when the debt cannot be paid off in a reasonable timeframe.
A more formal agreement may be more restrictive and harmful to their credit score and also goes against our ethic to encourage repayment whenever possible. However it could see them debt free in less time.
Struggling to pay
Martin (not his real name) lives in London and his story is typical of those who need a DMP.
He struggled to make ends meet and eventually turned to credit to pay for his basic living costs after losing his job. When he contacted the CCCS in 2008 he had £30,000 of debt.
After a counselling session he was recommended a four-year DMP, which he is now more than halfway through. In that time Martin has gone from having four creditors to one, having paid some of his smaller debts in full.
"When I lost my job, I turned to credit cards to pay for essentials. Eventually, I could not get more credit because I was too big a risk," he says.
"I have now paid most of my creditors, and will settle my debts in the next few years. My DMP has allowed me to take control of things."
Setting up a DMP
For those considering a DMP, you can arrange it yourself and there are internet forums that advise on the best way to go about this. It involves producing a budget - listing income, expenditure and debts - to show what money is available after essentials, utilities and priority bills are accounted for.
You then speak with each creditor in turn and ask them to accept lower monthly payments from any surplus amount.
However it can be a complex procedure to set up a DMP on an individual basis and it can be fraught with difficulties, not least negotiating with the very same lenders that are hounding you for money. For those in a fragile state of mind this is just too much to contemplate.
Instead we recommend that a third party arranges a plan on your behalf, so there is an intermediary between you and your creditors.
Having this buffer means that during this stressful period, when lenders and debt collection agencies are ringing you repeatedly with demands, you have someone else acting in your best interest.
The benefit of using an intermediary also comes from their relationships with the creditors. As they arrange thousands of DMPs each year, they are often in a better position to negotiate with the lender.
The downside is that many debt management companies will charge a fee for their work, on top of the debt owed. As such, to save money over the lifetime of the plan, and pay off the debt sooner, it is much better to talk with a charity or a not-for-profit organisation that set up and run DMPs for free.
DMPs provide a clear framework to paying off your debts and should your creditors agree to the plan they are incredibly practicable.
But if you cannot stick to the DMP payments, then other options might have to be considered, including formal solutions like bankruptcy or an IVA.
As such, DMPs are not the perfect solution in all cases. Your financial situation is the most important indicator of the whether one is right for you.
The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Links to external sites are for information only and do not constitute endorsement. Always obtain independent, professional advice for your own particular situation.