Paying off a large and burdensome debt can be challenging. Have you fallen behind in servicing your loan? Do you have an unmanageable number of cards? Are your payment higher than you can support? You can rest assured you’re not unique in such a situation.
The good thing is that you can choose several debt relief options to help you overcome your debt burden much quicker. Chief among your options is to use a Debt Management Plan (DMP).
But will a debt relief program such as a Debt Management Plan destroy your credit score? Before you set out to use a debt relief option, you should delve into and understand the pros and cons of using a debt management program.
How Do Debt Relief Programs Work?
Debt relief, also known as debt settlement programs, are programs rendered by third-party debt relief organizations to help borrowers find it difficult to service their loans and meet their debt obligations.
They work with their clients to help them save as much as possible, meet their other obligations, and pay their bills.
As the borrower continues to borrow, the company negotiates with creditors to lower the monthly instalments and interest rates on the outstanding interest owed. Generally, this should allow the lender to get full repayment while the borrower benefits from the relief of a more manageable repayment plan.
However, you should note that it does not always go to plan. In some circumstances, the relief companies cannot negotiate better payment terms for some or even all of your debts. In such cases, it can have a drastic effect on your financial security and credit score:
You might end up encountering the following:
– Paying exorbitant fees to the third-party debt relief company you’re working with
– Incurring late fees on the debt you already owe
– Antagonize and/or burn bridges with creditors you might need in the future
– Have a debt collection lawsuit filed against you
– Incur fees paid to a third-party bank
– Incur a negative score on your credit rating
How Do Debt Management Plans Work?
A Debt Management Plan (DMP) is an alternative to debt relief programs. Credit counseling organizations like credit.org offer DMPs to borrowers struggling to pay off their high monthly and/or multiple payments.
Credit.org works directly with its clients to establish the most suitable plan and solution for every situation, unlike any third-party organization. If you qualify for a debt management plan, you will work with a debt coach. The coach will also negotiate with creditors on your behalf to lower your monthly payments and interest rates.
It’s also essential to note that when you decide to participate in a debt management program, you agree to close any credit accounts you own. Moreover, your credit history also gets a notation to show lenders that you are on a DMP and cannot have or access any lines of credit. However, the notation is removed when you exit your DMP or complete your debt repayment.
How Will A DMP Affect Your Credit?
A notation of your credit history may send red flags initially after your line of credit is opened. However, the DMP does not have a long-lasting negative effect on your credit history
As part of the DMP, you must close all your credit accounts, effectively stopping your credit history. Credit agencies, including VantageScore and FICO, and lenders use your credit history to create a credit score. A halt on your line of credit, even if temporary, might have a negative effect on your score.
However, you can recover your score after you’ve left the DMP, as you will open your lines of credit and continue borrowing. In this regard, the notation placed on your credit history does not have a lasting effect on your score. It may signify to some lenders that you take debt repayment seriously and pull all stops to ensure you repay your loans.
Moreover, DMPs require you to pay off your debt with regular monthly instalments over a period of about 4 years. The terms of a DMP require the monthly payments to be automatically taken out of your bank account when they’re due. The timely payments over the 4 years you’re under a DMP will positively impact your payment history, and ultimately, it might affect your credit score.
Credit Score Breakdown
Are you wondering how much of a DMP can affect your credit score? Let’s break down your approximate credit score:
– 35% of the credit score is payment history. Regular and on-time DMP payments will positively impact your payment history.
– 30% of the credit score depends on credit utilization – basically, the amount you owe. A DMP will impact credit utilization as you pay the balance.
– 15% is pegged to the length of your credit history. The aspect of your score suffers you sign up for a DMP as your accounts are closed.
– 10% of your credit score is pegged on inquiring about new credit. This part of your score suffers as you cannot access any line of credit under a DMP.
– Finally, 10% of your credit score is reliant on your credit mix, which is individual-based.
You must note that your DMP requires monthly payments. If you cannot follow your plan strictly, your credit history and credit score will suffer immensely.