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How Each Debt Relief Program Affects Your Credit Score

man jumping with chart behindYour credit score has grown to be one of the most important figures that you will have to monitor in your financial life. Some people think that this is only for those who plan to take out a loan. It may be true that this will help paint you as a low risk borrower and will prompt the lender to give you a low interest on your loan. However, the effects will not stop there. It is also important because it will pave the way for you to enjoy various financial opportunities like better employment and even renting opportunities.

If you are in debt and you have been struggling with your payments, you can expect that your credit score have gone down. The extent of the damage will depend on your overall debt situation. While paying off your debt may be the priority right now, you need to think about fixing your credit ranking too.

This is why you need to make your debt relief choice depending on how much you can afford to sacrifice your score.

Debt consolidation has the least effect of credit reports

Among the debt relief options, debt consolidation has the least effect on your score. The options will also help you fix your score as you go through the whole process. The reason why this hardly has an effect is because you will still end up paying for all of your debts. That will not give the creditor any reason to put a negative entry in your credit report.

Here are the options that you have if you want to keep your credit score from being ruined.

  • Debt consolidation loan. This type of debt relief program involves getting out of debt through a loan that you will use to payoff your multiple debts. You will benefit from this because you will have a single and lower monthly payment. This happens because you will be getting a low interest on the loan that you will use to pay off your other debts. Not only that, loan terms are usually longer so your balance will be stretched over a longer payment period. This debt relief option may affect your score a little because the lender will have to get a copy of your credit report and that means an inquiry will reflect on your score. Not only that, your report will show a big debt amount – but this will only be for awhile. Once you get the loan, you will pay off the other debts completely and while that will not lower your score immediately, it will have a positive effect eventually. And since you only have a single and lower payment, the chances of you displaying good payment behavior is more likely to happen. That will boost your credit score slowly but surely. To maximize this option, you need that low interest and that requires a good credit score or a collateral. While there are loans for people with bad credit, this is not really advisable.

  • Debt management. In case you do not like using a loan, debt management is another option to consolidate debt. This involves a credit counselor who will help you by creating a debt management plan (DMP) for you. This plan contains your lower monthly payment proposal which is made possible not because you asked for a reduction, but because you stretched it over a longer payment period. This plan will be showed to your creditor and the counselor will also ask for a lower interest rate – but that is as far as their negotiations will go. Once the DMP is approved, you will send a single monthly payment to the counselor who will take charge of getting the respective payments to your creditors. This option will not have much effect on your score because there will be no inquiry on your report and your debt amount will remain the same. Not only that, the counselor will help make sure that you will not use your cards while in the program and that will keep you from incurring more debts.

Although these two can take care of your credit rating, you need to go through a longer payment period – around 5 years or less. Also, the lack of debt reduction may have kept your score intact but that also means you need a steady income to support your payments. If that is not possible, you may have to opt for other debt solutions.

Debt relief programs that can lower your credit score

In some cases, people really need a debt reduction simply because they do not have the money to pay all of their debts. It can be caused by job loss or an ongoing medical treatment. Anyway, there are debt relief programs that can arrange much lower payments but that could result in a negative entry in your credit report.

Here are your options.

  • Debt settlement. This debt reduction aims to convince the creditor that you are in a financial crisis so they will allow you to pay only a portion of your debts. Once you have paid that part off, the rest of your debts will be forgiven. You can probably understand how that will make your creditors hesitant to settle with you. The effect of this process on your credit score is when you default on your payments. To convince the creditor that you are in a financial crisis, you have to intentionally stop paying your monthly dues. Instead of paying your debt, you will put it aside, in a separate and secure account. You will grow that to be your settlement payment. This will lower your score because later payments affect 35% of your debt. And if you are dealing with credit cards, that would mean your debts will continue to increase as interest and late penalty charges will grow your balance. That affects your debt amount – which is 30% of your credit score. This is how your credit rating will be affected. If you will hire a professional to help with this program, you need to make sure it will be with a reliable company. To find legitimate debt settlement companies, you want to look for duly accredited ones and those who are members of reputable organizations like the AFCC or American Fair Credit Council.

  • Bankruptcy. The last option, and usually the last resort of people in debt is bankruptcy because it can lower your score for at least 200 points. This is because bankruptcy means you have put yourself in the lowest financial position that has no other way to recover except to have your debts discharged. When you go through this, future lenders and even potential employers and business partners may find you to be a risky investment. It signifies that you cannot be trusted with money. That is all reflected in your credit report. You need to think about all of this when you apply for bankruptcy.

While these credit score implications may be scary, remember that you can improve it. Bankruptcy filers may have a hard time in the next decade or so but if they really do not have a choice in terms of their financial capabilities, they need to face the facts. It may be difficult but there is a way to improve your credit score – even after bankruptcy.

By Diana Roberts
Diana hates debt just as much as you do. She is a finance writer for National Debt Relief. She aims to provide the best information to win the battle against debt.

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Comments

  1. Mighty One says:

    Hello NDR,

    Thank you for this information. Now I know how handle my debts better. What a great opportunity in reading this article. I will share this to friends.

    Just passing,
    Mighty One

  2. Mary Grace says:

    Just Sharing…

    I have been through bankruptcy. Yes, it has really affected my credit score- a LOT. It’s almost three years since I have filed for one, and I am now working on rebuilding my credit score. I am now very particular on my purchases so that I will not be facing my situation before again.

    Still hoping for best.
    Grace

  3. Sally Nachelle says:

    Credit score is a 3 digit number which convey your creditworthiness in the form of a numerical expression. Without a good credit score it’s very difficult to take out a home loan or a car loan. It’s true that debt relief programs lower your credit score by certain points. But it’s difficult to say by how much point it affects your score. It is extremely important to maintain a good credit score through out your life. If your credit rating is poor, then the lenders will not like to lend you money in future. They may even reject your loan application. There are many people who have some credit score myths such as closing old accounts will boost credit score, age as well as income determines score ,etc. But the actual fact is something else which most of the people don’t know. Check your credit report from time to time. If there is any error on your credit report, then you should report it to the credit bureaus immediately.

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