Debt Management Plans & Your Credit: What You Need to Know
One of the most frequent questions we receive from people interested in a Debt Management Plan is how the plan will impact their credit. Even though they may already be behind on payments, incur late fees, and receive collection calls, they do not want to do any more damage to their credit and credit score. While there is no magic wand for improving your financial situation or credit score, there are many things you can do to make improvements. A debt management plan is one good option.
What is a Debt Management Plan?
The debt management plan is designed to help people who are falling behind in payments, getting late or over-the-limit fees, or receiving collection calls and who have the means to make a monthly payment towards their personal debt.
Working with a certified credit counselor, a debt management plan allows you to consolidate your unsecured debt payments into one monthly payment. At the beginning of a debt management plan, you select a payment date that will work best for you. This payment is then distributed to your creditors. This allows you to effectively manage the cash flow of your household and helps to establish a consistent, on-time payment pattern to creditors.
How Debt Management Plans impact your credit score
While on the debt management plan (DMP), creditors may note on your credit report that you are on a plan or in, “credit counseling.” Being reported as late or delinquent can certainly hurt your credit scores, but a notation about credit counseling will not. In addition, Craig Watts, a spokesman for FICO (credit score) creator said, “The credit-score formula used by most lenders, known as FICO, now ignores any reference to credit counseling that may be in your file.” However, Bev O’Shea from NerdWallet.com notes, “Your credit score might initially drop, as accounts are closed and you have less available credit.”
Long term, as you continue to make on-time payments through the DMP, your credit score may increase. The most significant impact on a credit score is payment history. It accounts for 35% of the FICO score. Making your payments on time through the credit counseling agency is critical to paying down debt, increasing your credit score, maintaining creditor benefits, and improving your financial situation.
An important note when considering Debt Management Plans
Aside from the credit score, a debt management plan may also influence whether or not a lender will provide you with a loan. Some lenders look past the score in the report and if they see that you are enrolled in a debt management plan, they may not feel it is a good time to lend you money for additional debt.
There are many lenders that will work with people who are on a debt management plan. Often those lenders will request a letter from the credit counseling agency stating how long the person has been on the plan and verify that the person has been making their payments. "A typical creditor uses the scoring model. They don't look at the comment. They look at the scoring," says Maxine Sweet, former vice president of consumer affairs for Experian. “Paying off a big chunk of debt on your own or with the help of a debt management plan will give your credit score a boost,” says Sweet.
Benefits of enrolling in a Debt Management Plan
Enrolling in a debt management plan affects your relationship with creditors in many ways as well. There are many potential benefits offered by creditors to those persons who enroll in a debt management plan. They may include:
- Reducing interest rates on credit cards.
- Reducing or eliminating late and over-the-limit fees.
- Stopping collection calls.
- Avoiding having to pay the full balance upfront for accounts that are in collections and incurring additional costs like attorney and court fees.
One of the best benefits of a debt management plan is that you may be able to repay debts at an accelerated rate, usually in five years or less. The rate of repayment depends on benefits, such as lower interest rates, that may be extended by each individual creditor. A faster repayment is possible with lowered interest rates because more money goes towards the principal (the balance owed without fees or interest charges) of the debt each month. Also, by maintaining the same monthly payment amount, once the first creditor is paid off, that payment is distributed among the remaining creditors which increases the payment to them and, in turn, makes pay-off faster.
A Word from American Financial Solutions
American Financial Solutions is a registered, 501(c) 3 non-profit agency, part of the North Seattle Community College Foundation, and a proud member in good standing with the Better Business Bureau. We are accredited by the Council on Accreditation and the National Foundation for Credit Counseling. Read our excellent Trustpilot reviews here.
There are many factors to consider when thinking about using a debt management plan – your credit score is just one. Contact one of our certified credit counselors to learn more about the debt management plan and your other debt repayment options.
Blog updated March 23, 2023
Published Jan 1, 2012.