Which Is Better: Debt Management Plan or Bankruptcy?

Bankruptcy: Does the thought of it give you chills, but not the good kind? It’s a tough subject for many people. They know it can help, but they’re afraid of the stigma and the long-term consequences so they, understandably, look for other solutions.

Let’s look at how bankruptcy stacks up against one of its more popular competitors, the debt management plan.

What Is a Debt Management Plan?

A debt management plan, or DMP for short, is a program offered by a credit counselor to help you gain control of your unsecured debt by making one monthly payment to the credit counseling agency, which divvies it up among your creditors.

Most DMPs work like this:

1. You gather details on all your accounts and provide them to a credit counselor.
2. The counselor negotiates with your creditors to take a certain amount each month in lieu of regular payments. Often, the creditor will agree to lower interest, lower fees, or re-aging the account.
3. You agree to make one monthly payment to the counseling agency to pay off the debts as negotiated by the counselor over a certain period. 

Comparing DMPs to Bankruptcy

There are significant differences between DMPs and filing for bankruptcy, and while there are consequences of filing for bankruptcy, you may be surprised to learn that filing for it at the right time might work in your favor.

For the moment, that there are two kinds of bankruptcy that we’ll compare to DMPs. Chapter 7 bankruptcy is straight bankruptcy, which forgives debt without a payment plan. Chapter 13 bankruptcy is a payment plan that lasts from three to five years.

Learn more about how DMPs compare to each kind of bankruptcy.

How Long Does It Last?

• DMP: Payments usually last up to five years.
• Chapter 7: The process usually lasts four to six months.
• Chapter 13: The payment plan is three to five years.

Will I Be Protected From Creditors?

• DMP: No, but your credit counselor will attempt to secure the cooperation of your creditors; however, it is not required.
• Chapter 7: Yes. Bankruptcy’s automatic stay is an injunction against creditor collection activity.
• Chapter 13: Yes. It's the same as Chapter 7.

Are Debts Forgiven?

• DMP: No, but your credit counselor may seek concessions from your creditors to reduce interest, forgive fees, or re-age accounts.
• Chapter 7: Yes. This is called discharge. It applies to most debt, but some types of debt, like recent taxes and past-due child support, are not discharged.
• Chapter 13: Yes. Chapter 13 also discharges debts, but many of the non-dischargeable debts, like recent taxes and past-due child support, must be paid in full in the Chapter 13 plan. Unsecured debt, such as credit cards, will only be paid in a Chapter 13 plan if you have the income to cover it. Sometimes unsecured creditors receive a portion of their debt, and sometimes they receive nothing at all. But even if they’re not paid, they’ll be discharged if you complete your plan.

How Long Is the Payment Plan?

• DMP: The payment plan usually lasts up to five years.
• Chapter 7: There is no payment plan.
• Chapter 13: The payment plan is three to five years, depending on your income, expenses, amount of debt, and type of debt.

How Much Does It Cost?

• DMP: It usually costs around $25 a month.
• Chapter 7: Court filing fees are $338 (as of Dec. 2020), and attorney fees are $1,200 to $2,000 on average.
• Chapter 13: Court filing fees are $313 (as of Dec. 2020), and attorney fees are $3,000 to $4,000, usually paid over a period as a part of the Chapter 13 payment plan.

How Does It Affect My Credit Score and Credit History?

• DMP: The fact that you’re participating in a DMP isn’t calculated into your credit score, though it will be noted on your credit report. That said, other consequences of the DMP will have an effect. For instance, closing your accounts will affect the amount of credit you have available and could impact your credit history, both of which figure into the credit score algorithm.
• Chapter 7: Bankruptcy has a dramatic effect on your score and depending on where you started from, you’ll probably end up somewhere between 520 and 550. However, if you’re careful, you can raise that score dramatically to the point where you're in the "very good" to "excellent" range in two or three years. Remember that filing for Chapter 7 bankruptcy will stay on your credit record for 10 years.
• Chapter 13: A Chapter 13 plan will stay on your credit record for seven years from filing if you complete the plan, or 10 years if you don’t complete the plan.

What Debts Are Included? 

• DMP: Only unsecured debts like credit cards and medical bills are included. It won't include car loans, mortgages, student loans, taxes, child support, or alimony.
• Chapter 7: Most debts are discharged, but some are not. To keep your secured debts, like a car loan or mortgage, you have to continue making monthly payments.
• Chapter 13: Most debts are discharged. Some debts that are not dischargeable in a Chapter 7 case have to be paid in full in a Chapter 13 plan. To keep your secured debts, like a car loan or mortgage, you have to continue making monthly payments. There are circumstances in which you can add your car to your plan payment. You can also use the plan payment to catch up on past-due house payments and prevent foreclosure.

Do I Have to Qualify?

• DMP: You normally don't have to qualify if you enough income to cover your payments.
• Chapter 7: Yes. You have to pass a “means test.” If your income, minus certain expenses, is lower than the median income for your state, you pass.
• Chapter 13: No. There is no means test, but your proposed payment plan has to be feasible—that is, affordable based on your income and expenses. Chapter 13 does have an upper debt limit of $1,257,850 in secured debt and $419,275 in unsecured debt, effective April 1, 2019, and valid through the end of 2021.

Can I Get More Debt While I’m Participating?

• DMP: No. You’ll probably have to close the accounts that you’re including in the DMP, and you can’t seek out new debt when you’re in a DMP. Your creditors will be monitoring your credit report. If they see new accounts popping up, your DMP will be toast.
• Chapter 7: Not generally. But after your discharge, you’ll start receiving credit offers again right away.
• Chapter 13: You can't get more debt without permission from the bankruptcy court, and only for a really good reason, like to replace a car.

Will I Have to Give Up Any Property?

• DMP: No, just make your monthly payments.
• Chapter 7: Maybe, if you have a property that is not exempt. In the vast majority of chapter 7 cases, no assets are distributed to creditors.
• Chapter 13: No, just make your monthly payments.

How Do I Find Someone to Help Me?

• DMP: Look for a nonprofit credit counseling agency in your area that is a member of the National Foundation for Credit Counseling or Financial Counseling Association of America. Our list of the best credit counseling agencies is also a good place to start.
• Chapter 7 and Chapter 13: You can file a bankruptcy case yourself. It’s called filing “pro se.” But your likelihood of success is greatly diminished if you go it alone. There are many resources available to help you select a professional to guide you through this process.