Paying off large amounts of debt can be a daunting task. If you’ve recently fallen behind on payments, have more cards than you can manage, or have payments that are too high, rest assured – you’re not alone.
But do debt relief programs like Debt Management Plans hurt your credit? Before deciding which debt relief option is best for you, be sure to explore the following pros and cons of using a debt management program.
How Does Debt Relief Work?
Debt relief (or debt settlement) is a program offered by third-party debt relief companies to borrowers struggling to make debt payments. Typically, these companies encourage borrowers to use money meant for debt repayment for savings or for other bills and obligations.
While the borrower is saving, the company attempts to negotiate with creditors for lower interest rates and monthly payments on the remaining amount is owed. In theory, this creates a more manageable payment plan for the borrower and a full repayment for the lender.
However, these programs do not always go as planned. Many times debt relief companies are not able to negotiate a lower payment for all of your debts. This can have a drastic effect on both your credit and your financial security:
- You may end up paying large fees to the third-party company
- You may incur late fees on the debts you owe
- You may burn bridges with future creditors
- You may have to pay fees in a third-party bank account
- You may have a debt collection lawsuit filed against you
- You may have a negative impact on your credit score
How Do Debt Management Plans Work?
An alternative to a debt relief program is a Debt Management Plan (DMP). Credit counseling companies such as credit.org offer Debt Management Plans to borrowers who are struggling to make multiple or high monthly payments.
Unlike many third parties, credit.org works directly with every client to determine the best ways to handle every financial situation. If you qualify for a DMP, a debt coach will negotiate with creditors on your behalf to help get you lower interest rates and monthly payments.
When you agree to take part in a debt management program, you also agree to close all of your current credit accounts. A notation is made on your credit history to indicate to lenders that you are on a DMP and cannot have any new lines of credit. This notation is removed once you complete or exit your DMP.
How Does a Debt Management Plan Affect Your Credit?
The idea of having a notation on your credit history may initially send up red flags. But while a debt management plan does have an effect on your credit history, it does not have a lasting negative effect on your credit score.
When you agree to close all of your credit accounts, your credit history stops. Lenders and credit agencies like FICO and VantageScore use your credit history to generate a credit score. A temporary pause in your available credit may have a negative effect on your score.
However, once you’ve left your DMP, the freeze on your credit is removed, and you can continue to apply and use your credit. The notation signifying your DMP activity does not have a negative effect on your score going forward – in fact, it may suggest to lenders that you actively work to pay all of your debts to the best of your ability.
Additionally, DMPs are designed to be paid off with regular monthly payments over approximately 4 years. When you sign up for a DMP, your monthly payments are automatically taken out of your bank account every month. These timely payments over the course of years will have a very positive impact on your payment history.
Credit Score Breakdown
If you’re curious to see exactly how much of an effect a DMP has on your credit score, take a look at this approximate credit score breakdown:
- 35% of one’s score is payment history, which will be positively affected as long as DMP payments are made on time every month
- 30% of the score is based on amounts owed, or credit utilization, which will be positively impacted as the balances are paid down
- 15% of the score is the length of credit history, which will suffer under a DMP when accounts are closed
- 10% of credit score is based on inquiries for new credit, which the client will not have while on a DMP
- 10% of a credit score is one’s credit mix, which is unique to each individual
You should also keep in mind that a DMP has required monthly payments. If you do not continue to follow your plan, there will be a significant negative impact on your credit history and subsequently your credit score.
Debt Management Program Pros and Cons
Debt Management Program Pros and Cons
|Doesn’t directly impact credit
|Will not be able to get new credit
|Provides debt solution without direct impact to credit score
|Affects the length of credit history
|Consistent monthly payments improve credit score
|All credit account will be closed
|Amount of debt will be significantly reduced
|Debt is paid off significantly faster
Enrollment in a debt management plan doesn’t affect one’s credit score. However, certain facets of the program — timely payments, closing accounts, smaller amounts owed, and changes in utilization rate — may impact one’s score in both negative and positive ways.
Ultimately, clients who graduate from our Debt Management Plan have little trouble securing new credit and loans. If you’re ready to take control of your financial freedom, contact our expert debt coaches today.