One of the most effective methods of gaining control of troublesome debt, debt management programs can get you lower interest rates, fee concessions, and reduced monthly payments. This makes repaying your obligations easier to accomplish over a shorter period of time.
However, it also means your creditors must grant you certain concessions. Therefore, it’s more than reasonable to wonder; does debt management hurt your credit score?
Let’s find out.
How Debt Payments Affect Your Credit Score
Accounting for a full 35 percent of the weighting of your FICO credit score, your payment history is a significant aspect of your reputation with creditors. Falling into line behind payment history is credit utilization (30 percent), and the length of your credit history (15 percent).
Consistently paying your debts on time, keeping your balances as low as possible, and having a lengthy history of accomplishing both of the above will keep your credit score in the green. Meanwhile, participating in a debt management program can have an impact on your payment record, credit utilization, and the length of your credit history.
How Does Debt Management Work?
According to Freedom Debt Relief, one of the leading debt settlement companies out there, debt management companies — also known as consumer credit counseling agencies — work to negotiate interest rates that are lower than the ones you can receive on your own when you’re having trouble repaying your debts. These agencies can also enroll you in a debt management plan (DMP) through which you’ll make monthly payments to them, and they’ll distribute the funds to your creditors.
Generally speaking, you’ll have fallen behind on your payments when the realization you need to avail yourself of debt management becomes apparent. As a result, it’s likely your credit score will have already taken a hit. However, signing up for a debt management program — and sticking with it — will soon turn that aspect of your credit history around. After all, one of the tenets of a DMP is making timely payments to keep your negotiated interest rate and fee concessions in effect. This has the consequence of establishing a history of on-time payments, which benefits your credit score over time.
The basic rule of thumb in this regard is to keep your credit usage to 30 percent or less of your available credit. That’s on each of your accounts individually, as well as in total. If you’re struggling to keep up with your obligations, your balances can sometimes grow despite your payments. This is particularly true if you’ve been late a few times — or consistently — because fees are imposed whenever payments are late.
Added to the account’s outstanding balance, these fees increase the amount of money owed upon which interest is charged. What’s more, most credit card companies also impose an APR increase when payments are late. So now, you’re faced with paying off a larger balance at a higher interest rate — even while those additional costs are eating away at your available balance. This pushes you closer and closer toward a high utilization rate.
Yes, DMPs do help alleviate this situation, however, they also sometimes require you to close accounts, which can push your apparent utilization higher. This, in turn, can hurt your credit score.
Credit History Length
Closing older accounts remove them from your report — with the unintended consequence of making your credit history appear shorter. A long record of well-managed accounts looks much better than a short one in which you’re working to rebuild your reputation. Always close your newest accounts and keep the oldest ones open, if you’re given a choice. This will help mitigate that concern.
The Bottom Line
So, does debt management hurt your credit score?
Well, as wishy-washy as it sounds: yes it does and no it doesn’t.
Certain aspects of DMPs will drag your score down, while others help you build it up. Ultimately though, your credit score will eventually climb — if you complete the program successfully.