Will A Debt Management Program Ruin My Credit Score?
Credit counseling is a free review of your financial situation by a certified financial counselor and will not affect your credit score.
After receiving credit counseling, you may decide to join a debt management program to help you pay off your debts. Many people worry that joining a debt management program will negatively affect their credit.
Debt Management Impact on Credit Score
It’s complicated. Participating in a Debt Management Program can negatively impact your score. It can also have a positive impact.
While InCharge Debt Solutions does not report your participation in its debt management program nor take any action that would affect your credit score, some creditors will report that you are participating and some will show that you have elected to close your account. Closing several cards at the same time can negatively affect your credit score.
To understand how great of an effect closing your accounts can have, let’s examine the four major factors that determine your credit score and see how joining a debt management program may impact them.
History of On-Time Payments
The largest part of your score is based on your history of making on-time payments. FICO attributes 35% to on-time payments. Debt management program clients tend to score high in this category, since the program stresses on-time, automated and affordable monthly payments. If you suffer from late payments, a debt management program can help you establish a pattern of on-time payments, which will benefit your credit score.
Credit utilization is the percentage of available credit that you are using. If you have a balance of $9,000 and a credit limit of $10,000, you’re credit utilization is 90% ($9000 divided by $10,000 = 90%). As far as your credit score is concerned, the lower your credit utilization, the better. Experts recommend you keep your credit utilization at 30% or less. So, with the above example, you’d want to pay this card down to $3000 or less.
The goal of a debt management program is to pay off your credit card debt, so over time, if you stick with the program, you should see your credit utilization falling into optimal ranges. FICO attributes 30% of your score to this category.
However, if your creditors decide to close or freeze your accounts while you are on the program, your available credit is going to equal your amount owed, resulting in a credit utilization of 100%. This can have a negative effect on your score, but likely will be lessened as you make on-time payments on the program.
Length of Credit History
Length of credit history is the number of months you’ve maintained credit with a creditor. For a high credit score, the long – the better. Lenders want to see that you’ve had longterm, successful relationships with creditors. A history of opening and closing accounts every few months will hurt you. To help this area of your credit score, it’s always good to keep one credit card open for decades. Consider this your “legacy card.” Just make sure it doesn’t have an annual fee. FICO assigns 15% of your credit score to “length of credit history.”
Shopping around for multiple new credit accounts at the same time is a bad idea. It makes you look desperate for money and possibly unreliable in the eyes of lenders. You want to limit new credit applications, especially when you need to apply for a car or mortgage loan.
Joining a debt management program should have no effect on this area of the credit score. FICO assigns 10% to this category.
Types of Credit
Think of this category as a place to show how well-rounded you are. If you have different kinds of credit (mortgage loan, auto loan, credit cards) and you are paying them all on-time every month, this area of your credit score will be well taken care of. Lenders want to see that you have experience with more than just one type of credit. This only accounts for about 10% of your score. Joining a debt management program should have no impact on this portion of the score.
Impact on Your Credit Score
Ultimately, the best thing you can do for your credit score is improve your ability to make consistent, on-time payments and pay your debt off. Joining a debt management program or speaking with a credit counselor can help you with both of these two areas.
InCharge clients may see an initial drop in their credit score, followed by a steady increase as they make payments and pay off their debts.