All you need to know about debt and debt management

If you are in debt and despite your attempts, you haven’t been able to get out of it, you probably need a debt management plan. These are the essential things you should know if you are considering this option.

What is a DMP?

A Debt Management Plan allows you to pay off your debts at a rate you can afford. It's suitable if you have non-priority debts like credit cards, overdrafts, and personal loans. It is usually set up and managed by a third party provider,(for example a debt charity or debt management company) to which you make only one payment each month.  Your payment will go electronically to the counseling agency, which then pays your creditors.

These plans can be a lifesaver, but here are some pros and cons you should be aware of before you sign up for a debt management plan.

1. Debt management is not a loan, instead, you are creating a long-term plan to pay off the loans you already have.

2. Since debt management requires you to create a realistic repayment plan, It can take up to five years to complete.

3. Debt management can save you money each month because the payment you'll make to the counseling agency will probably be less than the total of all your debt payments now. This lower payment is often the result of waived fees and negotiated interest rates.

See also: Debts: Which are the most common ones and how to avoid them

4. A DMP isn't free, credit counseling agencies that offer these plans charge for their services, even if they are a non-profit. But the monthly fees collected by enrolled consumers typically fall in the $10-$15 range, so this amount is probably well under the savings you’ll have.

5.  Unlike debt settlement, which can cause your credit score to plummet, debt management, on the other hand, should actually increase your credit score as the process moves along.

Debt management is suited for people who are facing a less-severe financial hardship than a typical debt settlement customer, this means (generally speaking) consumers whose credit card debts are $7,500 or less.

Debt management might not be for everyone, but it may be just the right option for you. Not only will it help you get out of debt, but it will also teach you how to manage your money in a better way.

Though you could try to do it yourself, a debt management plan can do all of the tasks with you and may be the best option if you're feeling overwhelmed and need help to start.

What is a bad debt?

Debt becomes bad debt when the creditor has made all reasonable efforts to collect the debt but has been unable to do so. Often, this occurs when the debtor declares bankruptcy or when pursuing collection attempts further will cost more than the debt itself.

A company writes off bad debt as an expense, which reduces its taxable income. However, it also deprives the company of cash flow that is ultimately necessary to keep it in business.

See also: All you need to know about debt funds

Bad debt expense can be estimated using statistical modeling such as default probability to determine a company's expected losses to delinquent and bad debt. The statistical calculations utilize historical data from the business as well as from the industry as a whole.

The specific percentage will typically increase as the age of the receivable increases, to reflect increasing default risk and decreasing collectibility. Alternatively, a bad debt expense can be estimated by taking a percentage of net sales, based on the company’s historical experience with bad debt. Companies regularly make changes to the allowance for doubtful accounts, so that they correspond with the current statistical modeling allowances.

Canceled debt and taxes: things you should know

Many people have struggled to cancel their credit card debt to find out afterward that they were actually owing money for having that debt wiped away. Weird? Not at all!

This usually happens to consumers who have had part or all of debt forgiven. Although you might regain control of your finances by canceling debt, the IRS will still want its share of what it sees as income you received.

Here's a guide that can help you understand how this process works!

•    Canceling debt

First things first: How can you get your debt canceled? There are many ways debt can be forgiven on credit card balances, loans, mortgages, etc. One way is when you use a debt settlement company to negotiate a payment of less than you owe.

However, you should know that forgiven debt doesn't magically disappear. When the consumer doesn't pay off the debt, it becomes income and the government rectifies this by charging taxes on those forgiven amounts.

Bear in mind that when a creditor and debt collectors accept at least $600 less than the amount you owe them, they will have to file 1099-C forms (by law) and send you a copy to use it when you file your taxes.

•    There are exceptions

The IRS offers a few exceptions that allow consumers under certain financial situations to avoid paying these forgiven debts taxes.

Among these exceptions, you can find insolvency. This will apply in those cases in which after the debt is forgiven the consumer has no cash or assets to sell to pay the taxes.

Other exceptions include debt discharged in bankruptcy, debt given as a gift by a family member/friend, and certain business real estate.

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