What is a debt repayment plan?

Definition and Example of a Debt Repayment Plan

How a Debt Repayment Plan Works

Debt Repayment vs. Debt Management

Definition and Example of a Debt Repayment Plan

A debt repayment plan is a series of strategic steps you take to pay off your outstanding debts. If you attended college or purchased a car or house, it’s likely you have some form of debt. While debt isn’t always a bad thing, excessive borrowing can make it difficult to manage your monthly bills. If you’ve borrowed on a high-interest credit card, you might have to pay thousands of dollars in interest.

That’s why it’s a good idea to set up a debt repayment plan. A debt repayment plan helps you pay off your debts over time and gain more control over your financial future.

How a Debt Repayment Plan Works

A debt repayment plan is a framework you create to help you pay off your outstanding debts. You will take specific steps to lower your monthly bills and pay down your debts.

The plan that works for you will depend on your financial situation and preferences. Regardless of the steps you choose, a good debt repayment plan should include the following elements:

Calculate All Outstanding Debts

The first step you will take is to calculate all of your outstanding debts. Create a spreadsheet and list your debts in order of size or interest rate. Knowing how much you owe, what your monthly payments are, and how much you are paying in interest will help you formulate a debt repayment strategy.

Reduce Your Other Monthly Expenses

Next, you’ll want to look for ways to reduce your other monthly expenses so you can save money (if possible) to direct towards debt repayment. You can use a budgeting app to see how much you spend every month and look for expenses you can cut back on.

Reduce Your Debt Costs

You may also want to consider ways to lower your interest rates, so the overall cost of your debt decreases. For example, you could try negotiating with your lender for a lower interest rate, or obtain a balance transfer card or personal loan to consolidate high-interest credit card debt at a lower interest rate. This will, in turn, lower your monthly payments.

Choose a Repayment Strategy

Finally, you will choose a repayment strategy that works for you. There are two you might consider for repaying loans and credit card debts:

Debt Snowball: With the debt snowball method, you’ll start by paying off the smallest debt first while making minimum payments on everything else. Once you’ve paid off your smallest debt, you’ll roll that money into the next smallest debt, creating a “snowball” effect of payments with every step forward. Research has shown that borrowers are more likely to pay off all their debts when they focus on paying off the smaller balances first.

Debt Avalanche: With the debt avalanche method, you’ll list your debts based on their interest rates. You’ll then focus on paying off the debt with the highest interest rate first while keeping minimum payments on everything else. This plan doesn’t focus on the size of your debt; instead, the goal is to save the most money on interest payments.

Note: The advantage of the debt snowball method is that seeing progress right away can be very motivating to keep going. However, this means you might end up paying more in interest since you won’t be focused on the most costly debts in the beginning.

Debt Repayment vs. Debt Management

When facing debt, you might also consider a debt management plan. A debt management plan (DMP) is a type of debt repayment plan – but it’s done with outside help.

Repayment

Debt Management

A plan to pay off your debts over time is a type of debt repayment plan that is created and overseen by a third-party company.

You may set up the plan yourself and continue paying your creditors directly. A credit counseling agency will consolidate your debts and negotiate with creditors to lower interest rates and fees. You will make one monthly payment to that agency, which pays your creditors.

You may choose to keep your credit cards. You are required to close the credit cards included in the DMP so that you cannot use them to incur more debt.

There are no additional costs that may require reasonable fees.

While a debt management plan is more restrictive than a repayment plan that you set up yourself, you may find it beneficial to have more structure and support. A credit counselor reviews your financial situation and works with you to create a customized plan. They may also negotiate with your creditors to lower interest rates. Counseling usually includes information on budgeting and making payments and staying away from debt in the future. If you go this route, look for a credit counseling agency that follows the National Foundation for Credit Counseling or the Financial Counseling Association of America.

You may need to pay for the DMP. There may be an initial setup fee of $30-50 and a monthly fee (usually $20-75). If you choose the DIY method, of course, you won’t have those costs.

Note: Do not confuse nonprofit credit counseling companies with for-profit debt settlement companies. For-profit settlement companies often require you to stop making payments to your creditors entirely for several months in hopes of pressuring them into settling your debts for less than you owe. But there is no guarantee of success, and the process can ruin your credit score.

Key Takeaways

A debt repayment plan is a structure you put in place to pay off your outstanding debts. The key to a successful debt repayment plan is evaluating the total amount owed, figuring out how you can increase monthly payments, and finding a strategy that works best for your budget. The debt snowball method and the debt avalanche are two common strategies for repaying debt. A debt management plan involves working with a credit counselor to create a plan to repay your debts.

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Sources:

Consumer Financial Protection Bureau. “What Do I Need To Know If I’m Thinking About Consolidating My Credit Card Debt?” Accessed Feb. x, 2022.

Kellogg School of Management, Northwestern University. “The ‘Snowball Approach’ to Debt.” Accessed Feb. 7, 2022.

Consumer Financial Protection Bureau. “How To Reduce Your Debt.” Accessed Feb. 7, 2022.

Experian. “A Debt Management Plan: Is It Right for You?” Accessed Feb. 7, 2022.

Federal Trade Commission. “Coping With Debt.” Accessed Feb. 7, 2022.

Source: https://www.thebalancemoney.com/what-is-a-debt-repayment-plan-5218334

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