“Should I Get A Loan Or A Credit Card?”

I saw this question posed on a website by a young woman. She and her partner had mishandled their credit. They had several overdrafts and he had an old loan he had totally forgotten about. She wanted to pay off the overdrafts as well as the old loan and was wondering whether the best option would be to get a new loan or a credit card to pay then off.

Neither of the above

Most financial experts would say that they shouldn’t get either a new loan or a credit card to pay off their debts. The old saying, “you can’t borrow your way out of debt” is absolutely true. If this couple were to take out a new loan or a credit card, they would simply be moving their debt from one set of creditors to a new one.

A better alternative

It’s fairly clear that these young people are not great money managers. This means a better option for them would be to go to a consumer credit counseling agency for help.

How this would help

The agency would review all of their finances, including all their debts and combined income. It would contact all of their creditors and attempt to negotiate reductions in their interest rates. Following this, the agency would help them develop a debt management plan (DMP) for paying off their debts and then submit the plan to their creditors. If all of them accept the plan, they would then be required to send the agency just one payment a month. And this payment should be much less than the total of the monthly payments they’ve been struggling to make.

The downsides of a DMP

There are a few negatives to consumer credit counseling. For example, once this couple signs off on a DMP, they will be required to give up all of their credit cards. Moreover, the two of them will have to be very careful and not take on any new revolving credit until they’ve completed their payment plan, which could take anywhere from three to five years. They will have to be very scrupulous about making their payments every month or their plan could be terminated, leaving them in even worse trouble.

The effect on their credit scores

Enrolling in a debt management plan will have no effect on the couple’s credit scores. When people enroll in a debt management plan, a comment is usually added to their credit reports that they are paying through a credit-counseling agency but this won’t affect their credit scores. In fact, the company that calculates credit scores (FICO) says that since 1999, it has ignored any information about credit counseling when it computes a person’s credit score.

If you choose a debt management plan

If you’re struggling with debt and get a DMP, it can be painful in the short term because it will require self-discipline and probably more than a few sacrifices. However, once you get your debts paid off, you should have a better, less stressful life and a dramatically better credit score.