What is Debt Management?

Debt management is an agreement between a debtor and an unsecured creditor to manage the terms of outstanding debt. Debt management is done to protect both the debtor's and the unsecured creditor's interests. The debt management agreement specifies the terms and conditions for repaying the outstanding debt, as well as the interest rate and loan term.

Principles for Debt Management

Debt management principles are a step toward managing credits and protecting the interests of debtors and unsecured creditors. The fundamental principles of debt management revolve around minimizing the debtor's burden while also protecting the creditor's interests.

Understand your debt

The first principle of debt management requires the debtor to obtain a clear picture of the debt by compiling the details of each debt such as interest rate, tenure, amount, security against which each debt is obtained, and the due date of payments. Furthermore, the debtor should obtain a credit report from credit rating agencies, which will include a list of all debts as well as the debtor's credit score.

Prepare a budget

Once the debtor understands the specifics of the debt, the second debt management principle suggests developing a workable budget. The budget helps the debtor prioritize his or her spending. This allows the debtor to better manage his or her expenses and spending.

Only use credit for long-term purchases

The third important debt management principle states that debt should only be used for large purchases such as buying household appliances, furniture, or a home. Individuals should avoid debt for day-to-day purchases such as groceries and food.

Settle high interest rate debts first

When the debt with the higher interest rate is paid first, the individual saves a lot of money because the principal amount of the debt with the higher interest rate is rapidly reduced. As a result, the debt management principle suggests that high-interest debts be paid off first.

Negotiate with the creditor

If there is a problem with the timely payment of interest, the final debt management principle suggests approaching the creditor and seeking assistance. Furthermore, the creditor may be asked to lower the interest rate, extend the debt repayment period, or change the payment due date.

How does debt management plan works?

Debt management plans automate debt payments by consolidating all credit card and unsecured debts. Debtors must make a single monthly payment to certified credit counseling agencies under a debt management plan. These counseling organizations will distribute the funds to the appropriate creditors. Debt management plans help debtors get out of debt by handling multiple debt repayments.

Features of debt management plan

• Debtors are required to make single monthly payments under debt management plans. These single payments should be calculated based on the borrower's income and repayment capacity.
• After entering into a debt management agreement with the debtor, creditors offer reductions in debt obligations and interest rates.
• Debtors benefit from a flexible payment system under a debt management plan. After obtaining the creditor's approval, flexible monthly repayments are calculated based on the borrower's earnings.

Credit counseling agency

Credit counseling agencies assist customers with debt management by providing budgeting, money management, debt relief, and debt consolidation services. They provide debtors with worthwhile debt management and debt relief plans. Credit counseling organizations negotiate with creditors on behalf of debtors to extend credit periods, reduce interest rates, reduce credit card balances, cancel late fees, and reduce debt obligations. The credit counseling firm should be certified by the National Foundation for Credit Counseling (NFCC). Debtors must make single monthly payments to credit counseling agencies' accounts under a debt management plan. After receiving payment from the debtors, credit counseling organizations will settle the unsecured loans, credit cards, utility bills, medical bills, and other loans.

Debt consolidation services

Debt consolidation is a debt refinancing procedure in which the debtor settles all of his or her debts by entering into a single new debt obligation. Debt consolidation does not reduce the loan balance, but it does combine several debts into one. The debtor must pay back the new loan in accordance with the terms and conditions. This allows debtors to focus on a single debt payment rather than a number of liabilities. Consolidation loans are available from banks, financial institutions, and credit card companies.

Advantages of debt management

Flexible monthly payments

Debt management assists debtors in making affordable monthly repayments with the approval of creditors. The monthly repayment amount can be calculated based on the debtor's income.

Minimizes debt obligation

Debt management has a small impact on debt obligations and interest rates. In debt management, the creditor may be asked to lower interest rates, reduce credit card balances, extend the debt repayment term, or change the payment due date.

Avoids insolvency

Debtors who fail to make debt repayments are deemed insolvent or bankrupt. A debt management plan keeps debtors from becoming insolvent or declaring bankruptcy.

Reduces communication with creditor

All debt terms and conditions are clarified when creating a debt management agreement with a creditor. As a result, a debt management strategy reduces communication with creditors.

Disadvantages of debt management

Covers only non-secured credits

Debt management only applies to unsecured debts such as credit cards and personal loans. Debt management does not apply to secured loans.

Affects the credit score of the debtor

A debt management plan can assist in extending the credit period. Borrowers' credit ratings and credit scores are affected when they repay debts over a long period of time.

Context and Applications

This subject is important in general studies, professional exams, undergraduate and postgraduate courses, and competitive exams in business, finance, and management.

Practical Problems

Question 1: Which of the following is a step in the debt management process?

   a) Budget creation

   b) Preparing financial statements

   c) All of the above

Answer: Option (a) is correct.

Explanation: Debt management is the process of managing debts through the use of financial strategies, planning, and budget creation. Preparing financial statements does not fall under the purview of debt management.

Question 2: Which of the following is not a debt management principle?

   a) Budget creation

   b) Negotiation with a lender

   c) Learn about the lender’s capacity

Answer: Option (c) is correct.

Explanation: Learning about the capacity of lenders is not a concern in debt management. Debt management principles include being aware of your debt, prioritizing higher-interest loans, focusing on long-term purchases, creating a budget, and negotiating with lenders.

Question 3: Which is a part of the debt management strategy?

   a) Enter into a new loan after settling the old loan

   b) Single monthly payments

   c) All of the above

Answer: Option (b) is correct.

Explanation: A debt management plan assists borrowers in lowering their debt obligations. Borrowers are required to make single monthly payments to credit counseling agencies under debt management plans. Credit counseling agencies will pay the debts on the borrower's behalf.

Question 4: What is debt consolidation?

   a) Creating new debt obligation after settling existing debt obligations

   b) Reduce the total amount owed by negotiation

   c) None of the above

Answer: Option (a) is correct.

Explanation: The term "debt consolidation service" refers to the process of settling all existing liabilities by entering into a new debt obligation. Debt consolidation services do not reduce debt obligations; rather, they combine multiple debts into one.

Question 5: Which of the following is a benefit of debt management?

   a) Avoid insolvency or bankruptcy

  b) Affect credit score

   c) All of the above

Answer: Option (a) is correct.

Explanation: A debt management plan helps to avoid insolvency or bankruptcy. Due to some financial difficulties, if the borrower couldn’t make debt payments properly he will be treated as insolvent or bankrupt. But if borrowers entered into a debt management plan, these circumstances could be avoided.