Snowball Method vs Debt Management Plan (DMP)
There are a number of different ways to manage your debts if they have got out of control. Two of these are the Snowball Method and debt management plans.
These are similar debt management strategies in the sense that neither involve insolvency. Both methods involve you repaying your debts in full. However, there are also some fairly major differences between the two strategies.
The Snowball Method
The Snowball Method can be used if you have more than one debt. If you’re using this method to repay your debts you pay the minimum repayment towards each of your debts each month.
Any spare money that you have each month should be used to make an additional repayment towards your smallest debt. You should make the additional repayment towards the smallest of your debts even if some of your other debts have higher interest rates.
Once the smallest debt has been eliminated you should use the money you were using to repay that debt to make an additional repayment towards the next smallest debt, repeating the process until all of your debts have been eliminated.
The Benefit of the Snowball Method
Using the Snowball Method means that it will actually take longer to completely repay your debts and you will generally end up paying more than you would have paid had you used other debt repayment methods.
However, the Snowball Method works because being able to see the smallest debt being eliminated every few months gives you a morale boost. As a result, you are more likely to keep up the repayments and more likely to end up debt free.
A number of studies have shown that the Snowball Method is one of the most successful debt management strategies.
Debt Management Plans
Unlike the Snowball Method which you manage yourself without the people you owe money to realising that you are using it, a debt management plan is a formal agreement between you and the people you owe money to. Credit counsellors are often involved in setting them up.
In the UK debt management plans are regulated by the Financial Conduct Authority which has published a Debt Management Plan Protocol and can fine lenders for improper conduct.
Your income and expenditure are assessed to determine how much you can afford to repay each month. Then either you or your credit counsellor negotiates with your lenders so that a Debt Management Plan can be set up. A debt management plan will usually result in more affordable repayments each month, either by extending the term of your debts, reducing or freezing the interest on those debts, or a combination of both. Sometimes, some of the money you owe can be written off.
The Benefits of Debt Management Plans
Debt management plans give you a repayment plan that is affordable. Provided you keep up the repayments, they also put and end to the threatening letters and telephone calls asking you for money. Financial difficulties are one of the main causes of stress, and a debt management plan can put an end to this stress, letting you start to live your life again.
The other advantage of a debt management plan is that it gives you a date when you know that you will be completely free of debt. This gives you something to look forward to.
The downside is the fact that it can take several years or even a decade before your debts are cleared by a debt management plan and so it can be worth considering insolvency depending on how bad your financial situation. Although insolvency is a more drastic course of action taking that route could mean that you could become debt free in just one year.
The Effect on Your Credit Score
The Snowball Method is a completely private debt management strategy. Even your lenders will not know that you are using this strategy to manage your debts. As such, it will have no impact whatsoever on your credit score.
It’s a different matter where debt management plans are concerned because the fact that you are not paying the minimum repayments each month will be recorded on your credit history. This means that it will become more difficult to get credit, take out a mobile phone contract, etc.
However, if you need to use a debt management plan it is quite possible that your credit score is already bad. If you stick to the debt management plan and become debt free, this can ultimately have a beneficial effect on your credit score.
So Which is the Best?
If you cannot afford the minimum payments on your existing debts, the Snowball Method won’t be an option because this method requires you to make more than the minimum payments each month. If you are in this situation, a debt management plan would be more appropriate.
If willpower isn’t your strongest suit, the Snowball Method might not be the best option for you either. If you are using the Snowball Method, making the extra repayments is voluntary and it can be tempting to spend the money on other things instead. Under a Debt Management Plan you have no choice when it comes to how much you repay because you have to make the repayment amount set out in the agreement each month.
The downside of a debt management plan is that although the end result will be worth it, while you are making the repayments if can feel like your life has been put on hold and debt management plans can last for many years. The Snowball Method can also mean that it takes a long time to clear your debts but while you are clearing those debts you feel less like you are a prisoner, partly because it’s voluntary and partly because you get regular reminders that you are making progress as each of your debts is cleared,
Essentially, a debt management plan is the better of the two options if your debts are seriously out of control. If your debts are manageable but it’s just that you feel that you need to do something because those debts have got slightly out of control the Snowball Method is a considerably less painful approach to debt management, provided you have sufficient willpower to make the additional repayment each month.
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