- Applying for or participating in a credit counseling program is not considered in credit scoring algorithms.
- Debt management plans, required as part of credit counseling and often the debt relief route taken through credit counseling, will have both a direct and indirect impact on your credit.
- You will be required to close all accounts enrolled in a Debt Management Plan.
- Closing accounts will increase your utilization rate ad decrease the average life of your credit history, negatively impacting your credit score.
- The credit counseling agency will enter a notation on your credit file that your account(s) have been enrolled in a debt management plan, making it difficult or impossible to obtain new credit.
Credit counseling companies typically function as non-profit agencies. However, they are not impartial. Most agencies receive compensation from lenders to complete debt management plans that require you to repay enrolled debts in full plus interest.
Services Offered by Credit Counseling Companies
Non-profit organizations offer credit counseling services, often at no charge to clients. The actual credit counseling will include an in-depth discussion of your finances, along with a detailed look at income and expenses. Additionally, counselors review your credit and assist you with creating a financial plan to eliminate or reduce debt through a payoff strategy which can last up to five years. This payoff strategy is referred to a Debt Management Plan.
If you choose to accept the proposed debt management plan, you will pay a monthly fee to the credit counseling agency for their services in managing this plan for you and distributing your payments to your creditors. Once enrolled, you make a single monthly payment to the credit counseling agency, which in turn pays your creditors. The company will also contact creditors on your behalf to request a lower interest rate or waived fees. During the term of the debt management plan, interest on your debt will continue to grow, compounding daily.
Credit Impact of Credit Counseling
Speaking with a credit counselor will have no impact on your credit score. The counselor can help you dispute inaccurate information in your credit file, provide advice on money management, and assist with a debt reduction strategy.
Entering a debt management plan, however, can impact your credit score significantly in the following ways:
Debt Management Plans (DMP) and Their Impact on Your Credit Score
Repayment Schedule: In a DMP, you make a single monthly payment to the credit counseling firm each month. The company then distributes payments based on the repayment plan. You have no control over when the agency pays creditors, which could lead to late payments and late charges. Credit card companies receive money a day past the due date will charge a late fee and it could result in a negative mark on your credit file. It is not uncommon to miss payments during the transition into a debt management plan.
Settled Accounts: Even though you are paying the full principal balance, if the creditor waives fees or reduces the interest rate on the account, they can list it as ‘settled for less than the full balance,” which can negatively impact your credit.
Closed Accounts Reduces Length of Credit History and May Increase Utilization: Accounts enrolled in the DMP are closed at the start of the repayment plan. Closing accounts can adversely impact your credit score because it could affect both the length of your credit history as well as your utilization rate. By closing accounts, the life of the credit history is no longer calculated in your credit score and the available credit will go to zero, causing your utilization rate to be 100% on each enrolled account for the duration of the Debt Management Plan. These factors can easily cause 75 to 150-point drop in your credit score depending on your individual situation.
Notations on your credit file: When credit counselors contact creditors to negotiate interest rates and lower fees, the creditor will place a notation on your credit file that the account has been enrolled in a debt management plan. This note does not have a direct impact on your credit score, however, it does send the message to creditors that you are unable to manage current debt levels, which will impact your ability to obtain new credit.
Limits availability of new credit: The notation on your credit file, combined with the lower credit score can limit your ability to obtain new loans or lines of credit, even though you are making on-time payments and repaying creditors in full.
History of Payments: Maintaining good credit depends heavily on an active payment history. Closing multiple credit accounts will stop ongoing payments. In some cases, it may be necessary to start over reestablishing your credit file.
Although credit counseling is not into any credit score algorithms, it can have both a direct and indirect impact on your credit score and make it challenging to obtain new credit while in the program. Additionally, you will need to be able to show documented income and available cash flow sufficient to pay back 100% of the outstanding balance plus daily compounding interest in all enrolled accounts over a period of 5 years or less.
What Are the Factors Affecting My Credit Score?
Credit scores use five primary factors to calculate your score. These include on-time payments, credit utilization, length of credit history, new credit, and the mix of credit types.
Will Credit Counseling Hurt My Credit?
The impact closing account enrolled in a Debt Management Plan, which will increase your utilization rate and decrease the average life of your credit history, will both likely have a detrimental impact on your credit score.
How long does credit counseling stay on my credit file?
Credit counseling becomes a notation on your credit file when you sign up for a debt management plan. It remains in your credit file for seven years.