Debt Management vs. Debt Settlement: Which Is Best?

Financial Costs
Costs vary to use different debt elimination programs. But $25 a month is a common monthly fee for many debt management services. Most debt settlement companies charge you in one of two ways:

• a flat fee, which often runs $1,000 or more, and is based on how much money the debt settlement "saves" you by negotiating with your creditors
• a percentage fee, typically ranging from 15 percent to 20 percent of your total debt

So if you have $10,000 in debt, fees would run about $900 for a typical three-year debt management plan, compared with fees of $1,500 to $2000 for a three-year debt settlement program

Many debt settlement firms also charge an additional monthly fee to their clients. These fees range from $20 a month to $100 a month. Fortunately, thanks to financial reform, since Oct. 27, 2010, debt settlement firms have been banned from charging upfront fees for their work, as they had done in the past.

Tax Implications
There are no tax implications of using a debt management program. If you enter into a debt settlement plan, however, you will have to pay taxes on the amount of money you saved.

For instance, if your debt was $10,000 and the debt settlement company convinced your creditors to settle your debt for only $3,000, you will be required to pay taxes on the $7,000 you saved. If you are in the 25 percent tax bracket, you'll have to fork over $1,750 to the IRS, because the government deems your $7,000 in savings as income.

The Winner: Debt Management
As you've probably surmised, I'm not a big fan of debt settlement firms because even with the "best" of them, you often pay high fees, suffer negative tax consequences, severely damage your credit rating, and get scant financial education to help you learn how to use credit and debt wisely.

Also, with debt settlement companies, your "success" in getting rid of your debt is tied to the company's ability to negotiate a settlement with your creditors — something that can't be assured since some creditors will simply refuse to cave in to a debt settlement company's demands.
 
By contrast, a reputable debt management company will provide free or low cost services, can help you preserve your credit rating, and will have financial literacy offerings as well to teach you to properly manage your overall budget.

A good debt management agency will also more successfully deal with your creditors because debt management firms have existing relationships and pre-arranged agreements with the creditor community to get you financial relief.

Lynnette Khalfani-Cox, The Money Coach®, is a personal finance expert, television and radio personality, and a regular contributor to AARP. You can follow her on Twitter and on Facebook.