How Debt Management Plans Affect Your Credit
How debt management plans affect your credit: When it comes to paying off a lot of debt, few methods are as efficient and effective as a debt management plan. While it’s one of the more extreme measures, in many ways, it can also be a direct path to debt freedom.
A debt management plan (DMP) is an agreement between you and a debt management entity that allows them to be your advocate to your creditors. You will no longer receive harassing phone calls, as those will be handled by a third party. Your debt manager will also work to negotiate better terms, effectively taking the heat off of you. But debt management plans come with a few stipulations, and they do have an effect on your credit score.
When you agree to work with a debt management company, they will devise a plan tailored to you, but there are a few basic terms common to all DMPs. Let’s look at the details.
The Good:
- You get a debt coach. Someone will be there to walk you through the process from the very first phone call to the final payment. You will have a debt management expert working with you and working for you.
- They will negotiate lower interest rates and lower monthly payments. An experienced financial advisor will deal with your credit card companies and get you the best terms available.
- Your debts will have a definite pay-off date. DMPs typically last from 4-6 years – and at the end of the plan, your debts will be paid in full. There is light at the end of the debt tunnel.
- Your credit score will not be reduced due to being on a DMP. In fact, if you have been inconsistent with payments in the past, your score could rise over time due to consistent and timely monthly payments, eventually leading to paid off debt.
The Bad:
- You agree to temporarily stop using all credit accounts. DMPs are designed to help you get out of your current debt without incurring any more debt. To that end, you must agree to stop using all accounts that are a part of the plan. It is important to note that this is only temporary. These accounts are not typically closed, but more often merely frozen and may be used again once you complete or exit the plan.
- You will not be able to open any new lines of credit. For the same reason your credit accounts will be temporarily frozen, you will also not be able to apply for any further credit while participating in a DMP. This, again, is only temporary. Once you’ve completed or exited the program, you will once again be able to apply for credit – this time possibly with more favorable terms if you have improved your credit status for completing the program.
- A Notation is made on your credit report that you are enrolled in a debt management plan. This notation will be removed once you’ve completed the program, but it may cause creditors to deny you new credit while on the program.
According to FICO, they do not modify a person’s score for being enrolled in a debt management plan, which is good news for the consumer. However, as pointed out above, you may see a negative impact to your ability to open new credit lines as a result of some of the plan’s requirements. Over the course of the plan, though, the positive effects of completing the program have the potential to outweigh the temporary negative ones.
This is because FICO scores are calculated in a very precise way. Understanding how these scores are tabulated will help you better understand what can happen to your credit score over time, while participating in a debt management plan.
Your Credit Score and How It’s Calculated:
- 35% payment history. This is the largest factor in determining your credit score, which is why making payments on time is so important.
- 30% amounts owed. In essence, the more you owe, the worse it looks on your credit report. If you want to improve your credit score, paying off high amounts of debt is the second-most important thing you can do.
- 15% length of credit history. This refers to how long your credit accounts have been open. If you have a long (and strong) history with creditors, this reflects positively on your credit report. This is why successful repayment of older debt can be a real boost to your overall credit score.
- 10% new credit. Since you will not be able to apply for new credit while on a DMP, you will not see any benefit from this category.
- 10% credit mix. This last category is unique to each individual, and while important, is not necessarily affected either positively or negatively by a debt management plan.
If you’ve tried some other debt repayment options such as the snowball method or debt consolidation, but you are still struggling with multiple debts and high credit card payments, it may be time to look at a more aggressive approach. Talk with one of our helpful team members at American Credit Foundation to see if a debt management plan is right for you.