Debt Management Plan is an agreement between the creditor and debtor to lay down the terms for resolving and repaying an outstanding debt. Let us see the need and benefits arising out of the debt management plan. Repayment during normal scenario: During a normal period, the borrower repays the loan within the repayment term at the agreed rate of interest. But the situation may not be always normal. Due to unforeseen financial difficulties, the borrower may find it difficult to repay the loan.
This affects the borrower in the following ways
- Irregular/Nonpayment will result in a bad credit history.
- This will make it tougher to get new loans
- Due to nonpayment, debtor lands himself answerable to legal suits of the creditor.
- Nonpayment and subsequent legal action may lead to losing assets like home, car etc.
- The debtor has to bear the social stigma for non-repayment of the loan.
Nonpayment of the loan also affects the creditor in the following ways
- He might have used the borrowed capital to lend the debtor. Now his repayment and credibility are affected.
- Profitability of the creditor is affected
- Legal suits are expensive and time-consuming. In spite of these, he has to initiate legal suit
- Risk appetite of the creditor is affected. This will impact the business growth and economy as a whole.
Why debt Management:
Debt management is needed when the borrower is not able to repay the debt within the agreed repayment term. This may be due to unexpected reasons like sudden unemployment, business losses etc. Hence the repayment of the loan may not be as smooth as expected. Under such circumstances, a debt management company works out a plan between debtor and creditor which serves as a solution so that the loan is repaid through any of the following:
- Reduce outstanding debt: Where the creditor agrees to write off a certain amount outstanding so that the amount to be repaid becomes less.
- Reducing rate of interest: The creditor agrees to charge a lower rate of interest so that the EMI gets reduced.
- Increasing repayment term: By increasing the repayment term the amount of EMI gets reduced as the outstanding amount is spread across an extended period now.