Does a Debt Management Plan Hurt Your Credit?

Participating in a debt management program (DMP) can work wonders for your credit scores… as long as you stick with the plan.

Yes, you might see your credit scores drop when you initially enroll in a DMP, but these plans give you a pathway to becoming debt free over the course of three to five years, and they can help you avoid major credit score killers: having debt go to collections and filing bankruptcy.

In other words, the short-term blip on your credit scores is worth the long-term gains. If you stick to the plan, your credit scores should steadily improve, and you can gain 100 points or more.

Factors That Affect Credit Scores

What are the two most critical factors in calculating credit scores? Making on-time debt payments and reducing your debt. In fact, these two factors make up 35% and 30% of your score calculation, respectively.

Since a DMP helps you in both areas (and gives you a boost in other parts of the score calculation, too) it can lead to major success in raising your credit scores. Here’s what you need to know.

History of On-Time Payments

The primary reason people look into debt management programs is because they’re having problems with credit card payments. Enrolling in a DMP helps you turn that around.

When you’re on a DMP, you can expect to see your credit improve in this category, because the program stresses on-time, automated and affordable monthly payments. As an added bonus, some creditors will also erase missed payments from the past that are harming your scores.

Ultimately, InCharge credit counselors get you in the habit – and keep you in the habit! – of paying bills on time. Their real goal is to help you establish a pattern of on-time payments, which will raise your credit scores.

Amounts Owed

The second most important category in determining your credit scores is your credit utilization, or the balances you owe on your cards versus the limits. The lower the percentage of the cards’ limits you owe, the better your scores will be.

Owing money on a credit card is not a bad thing if you pay down the debt every month. But more than 55% of credit card users carry a balance from month-to-month. When you do this, your interest charges can keep you from ever getting out of debt, you risk falling behind on payments and your credit scores drop.

How does a DMP impact your credit scores in the area of amounts owed?

• Short term: Your creditors usually require you to close all but one credit card account, and that could have a temporary, negative affect on your scores since it eliminates available credit.
• Long term: Your credit scores can significantly improve as you work on paying down, and eventually paying off your balances.

Length of Credit History

Another factor in your credit scores is your length of credit history. This factor only makes up 15% of your scores, but it’s still worth considering. Here’s what impacts your length calculation:

• Age of your oldest credit account
• Age of your newest account
• Average age of all your accounts.

In essence, the longer your history of using credit, the better. By contrast, a history of opening and closing accounts every few months will hurt you.

The fact that you will be asked to close all but one credit card on a DMP can hurt you in this area. However, if the one card you keep has been open for a decade, the impact could be minor. Consider this your “legacy card.”

Just make sure it doesn’t have an annual fee. Then, use it sparingly and pay it off immediately.

New Credit

A small part of your credit scores (just 10%) is based on your recent applications for new credit. The more applications, the more points you can lose. One reason for this is that frequent applications make you look desperate for money, and it’s a sign of financial trouble.

DMPs don’t have any direct impact on this area of your credit scores. However, it’s not a good idea to take on new debt while on a DPM, and you may even have a hard time qualifying for new loans and credit cards during the first year or more of your DMP.

Types of Credit

With this credit score category, you get a chance to show creditors how well-rounded you are. If you have a variety of account types — such as a mortgage, car loan, student loans and credit cards — and you pay them on-time every month, this area of your credit scores will be taken care of.

But types of credit only make up 10% of your scores, so it’s definitely not worth taking on a new debt account to get a boost in this area, especially if there’s a chance you’ll miss payments.

Joining a debt management program will have no impact on this portion of your scores.

Debt Management Programs on Your Credit Report

Once you enroll in a DMP, some of your creditors may note on your credit reports that you’re enrolled. Future lenders and creditors might see this, and it could cause them to think twice before approving your applications.

However, a notation that you’re on a DMP has no effect whatsoever on your credit scores.

In fact, some lenders read the DMP note as a positive sign, since it shows you’re proactively looking for a way to stay on top of debt payments and you’re avoiding bankruptcy.

Why Did My Credit Scores Drop After Paying off Debt?

When people ask “Why does paying off debt lower my credit scores?,” they’re actually referring to the fact that closing debt accounts after paying them off can reduce your scores.

With DMPs, you will see an up-front loss of points once you close your credit cards, since this can reduce your available credit and your length of credit history.

However, your scores can recover if you stick with the program. Over the long-run, you’ll see your credit utilization fall. Along with making on-time payments, this will help you build strong credit.

Impact Debt Management Program Has On Credit Scores

What’s the best way to improve your credit scores? By making consistent, on-time debt payments each month and by reducing your debt. Fortunately, joining a debt management program, or even just speaking with a credit counselor, can help you make progress in both areas!

Yes, it’s true that for the first eight to 10 months of a DMP, your scores could take a hit. Between closing accounts and late payments that could show up while you’re negotiating DMP details, your scores could drop noticeably.

You might feel the negative impact of that initial score drop if you look for a new loan or credit card. However, this is a temporary blip that generally passes after six consecutive, on-time payments. Most people end up gaining at least 80 points overall.

The bottom line? Enrolling in a DMP can rid you of credit card debt. Once you’re debt-free, you’ll like the impact on your credit scores. Plus, you’ll be eligible for better interest rates on mortgages and car loans.