Paying off debts can be overwhelming. You should not be embarrassed about asking for help. If you are searching for a way to pay off debts, you may have considered a debt management plan. However, you may be concerned with how a debt management plan could affect your credit score and your credit report. If so, you are not alone. Most people who need to pay off debts worry about how their debts affect credit scores and credit reports.
What is a Debt Management Plan?
A debt management plan is a three to five-year payment plan designed to get rid of your unsecured debts. Unsecured creditors do not have a lien on collateral to secure the amount you owe. Examples of unsecured debts include credit cards, medical debts, most tax debts, old rent payments, and most personal loans.
Secured creditors have a lien they can execute if you fail to pay the money you own to the creditor. Examples of secured debts include mortgages and car loans. Secured debts are not included in a debt management plan. Also, creditors who have wage garnishment orders are not included in debt management plans.
A credit counseling agency or other organization calculates how much money it takes to pay off your eligible unsecured debts over three to five years. There are a few advantages of working with a debt management company:
- You do not need to worry about paying any debts included in the plan each month. The company pays those debts each month from the amount you pay to the company.
- Your combined debt management plan payment should be lower than all the bill payments combined.
- The debt management company often has agreements with major lenders and creditors to lower interest rates and waive fees to help pay off the debts faster.
However, there are also disadvantages of debt management plans. Debt management companies charge monthly fees for their services. Some companies may charge costly upfront fees, and there could be hidden costs the company includes in your monthly DMP payment. You have to close your credit card accounts and other loan accounts included in the plan. Most companies require automatic monthly drafts for the debt management plan payments.
We discuss debt management plans in more detail in our article, “Debt Management: Everything You Need to Know.”
Can a Debt Management Plan Hurt My Credit Score?
Being in a debt management plan can hurt your credit score in several ways. However, there are also some ways that a DMP could help your credit score. Ways a debt management plan impacts your credit score include:
1) Notations of Debt Management Plans
The credit reporting agencies generally do not have a specific notation for DMPs. However, creditors that agree to be included in a DMP may notate that the account is included in a debt management plan, which could negatively influence new creditors as they consider whether to lend you money.
On the other hand, some lenders may view notations of a DMP as a positive indication that you are taking steps to pay off your debts in a responsible manner. They may also view your actions as a positive step to avoid bankruptcy.
2) Payment History
Payment history accounts for 35 percent of your credit score. If a debt management company negotiates a lower payment amount, the creditor may report partial payments on your credit report. The partial payments could lower your credit score.
On the other hand, if the debt management plan pays at least the minimum amount due to each creditor and pays those payments on-time each month, the DMP could help improve your credit score.
3) Closing Credit Accounts
Most companies require that you close the accounts included in your debt management plan. One individual noted that the mortgage proposed increased his rate because of the accounts showing up as closed. Another individual noted that his credit score dropped from 555 to 521 since enrolling in the debt management program. When you close the account, you lose the benefit of credit history. Your credit history makes up 15 percent of your credit score. Closing good-standing accounts can have a negative impact on this area of your credit score.
There is also another consideration. Closing accounts lowers the amount of money you can borrow (credit utilization ratio). A lower credit utilization ratio is better for your credit score. Therefore, closing the accounts improves one area of your credit score, but it may hurt another area at the same time. The benefits could offset each other depending on other factors used to calculate your credit score.
4) Applying for New Credit
Some people in debt management plans apply for new credit because they had to close their credit accounts or cannot use their credit accounts included in the plan. However, applying for new credit can also hurt your credit score. If you apply for several new lines of credit within a short period, it can lower your credit score, and potential creditors view you as a higher risk. Therefore, rushing to apply for new credit could undo the positive impact of paying off debts.
What Should I Do – What is the Best Way to Get Rid of Debts?
Every person’s financial situation is unique. Other factors might impact your credit score that outweighs any negative or positive impact of being in a debt management plan. The bottom line is that you should consider all factors carefully before entering a debt management plan.
The road to financial stability and good credit scores is different for each person. Paying off debts on-time and lowering your debt-to-income ratio can improve your credit rating.
However, the way you get rid of debts can have a short-term impact on your credit score. For example, filing bankruptcy decreases a person’s credit score in most cases. Debt settlement also decreases credit scores because some of the debt is “written off” by lenders. As discussed above, debt management plans can also impact your credit scores in negative and positive ways.
The important thing to remember is that most plans to pay off debts have a temporary negative impact on your credit score. The degree of the impact depends on your unique financial situation and the plan you choose to get rid of debts. By comparing the various debt-relief options, you can choose the option that gives you the best chance of getting out of debt with the least negative impact on your credit score.
Consider the Savvy Method for Paying Off Debts
Ascend has developed what we call the Savvy Method for paying off debts. It puts control of your finances in your hands. Through the Savvy App, you take control of your debt through managing your budget and automating debt payments.
The only way to avoid negative impacts on your credit scores while paying off debts is to pay at least the minimum payments due each month before the due date while avoiding incurring new debt. Savvy can help you with both of these goals. With each monthly payment, you are working to increase your credit score and get rid of debts.
Comparing Options for Paying Off Debts
There is no right way to pay off debt that applies to every situation. However, some ways to get rid of debts may be better than other debt-relief options, given your financial situation. The best way depends on numerous factors.
At Ascend, we want to help you find the best way for you to get out of debt. The Savvy Method may work best for some people, while other individuals may need the assistance of a debt management agency. Some people may find that debt settlement works best in their situation, while filing bankruptcy may be the best option for some individuals.
We are dedicated to providing individuals with the information and resources they need to get out of debt. Contact Ascend by calling 833-272-3631 to talk with a knowledgeable member of our team. You may also read our guides and resources available free of charge online for more information about debt relief options.