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How Does a Debt Management Plan Affect Your Credit Score?

Navigating Finances with a Debt Management Plan (DMP)

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Credit Sesame discusses the effect of a debt management plan on your credit score.

If you’re struggling to make your credit card payments, you might consider credit counseling and a debt management plan. The plan may help you become debt-free faster, but how does it affect your credit rating?

How does a debt management plan work?

It’s important to understand how debt management plans (DMPs) work before you decide to enroll in one. Credit counseling firms offer DMPs to help consumers afford their credit card payments. The DMP is a form of debt consolidation — the consumer enrolls multiple credit card accounts into the plan and makes a single monthly payment. The credit counselor takes that monthly payment and distributes it among the credit card issuers.

Typically, credit counselors negotiate better terms with your creditors — lowering your interest rate, waiving late fees and penalties, or reducing your minimum payment. If you’re behind on your payments, credit counselors may also convince creditors to “re-age” your account. That means bringing past-due accounts current, which eliminates “rolling” late payments. In exchange for these concessions, you have to close all credit card accounts and focus on paying off your balances.

When consumers can’t qualify for refinance loans with better terms, DMPs may be their only debt consolidation option.

Do debt management plans report to credit bureaus?

Debt management plans do not report to credit bureaus, and enrolling in a debt management plan won’t add a new tradeline to your credit report. However, credit card companies could choose to add a note to your file indicating that the account is being paid through a DMP. That note does not impact your credit score.

How a debt management plan affects your credit score

Enrolling in a DMP can immediately raise or lower your credit score:

  • Re-aging accounts and bringing balances current can quickly reverse past delinquencies and improve your score.
  • Closing credit cards increases credit utilization, which causes scores to drop.

First, let’s see how re-aging can improve your credit score. Re-aging means reporting past-due accounts as current. It does not mean forgiving missing payments.

Re-aging

Suppose you experience a money problem and can’t make your credit card payment in July. In August, you solve your problem and are able to make the August payment. But the credit card company applies your payment to your 30-day past-due amount from July. In September, it applies your September payment to your past-due balance from August and reports you 30-days late again.

If you can’t catch up by making an extra payment, you are late month after month, even though you only actually missed one payment. That’s called a “rolling late” and it can do huge damage to your credit score.

Once a creditor re-ages your balance, on-time payments won’t be reported as late. And if rolling lates are changed to on-time, your credit score may increase. Note that most credit card companies won’t re-age your accounts until you’ve made several on-time payments into your DMP.

Closing credit cards

Enrolling in a DMP means you have to close your credit cards. All of them, even if you don’t put them all into the plan. And that affects your credit utilization ratio, which makes up 30% of your credit score.

If, for instance, you have three credit cards with $20,000 in credit, and your balances total $10,000, your utilization ratio is 50%. ($10,000 credit used / $20,000 available credit = 0.5 or 50%.) Enrolling in a DMP can raise your utilization sharply because when you close a card with a balance, whatever you still owe counts as used credit. However, the credit limit on that card drops to zero.

In this example, your credit utilization changes from 50% to 100%. ($10,000 credit used / $10,000 credit limit = 1 or 100%) That’s a big jump and it harms your score. On the other hand, your credit score might not suffer if you’re already maxed out when you enter a DMP.

DMP and credit score: after graduation

You may be dismayed if your credit score drops after entering a DMP. However, making your payments into the plan in time helps you build good repayment history. And once you complete your plan, you can reestablish credit.

If you kept up with other accounts like auto financing, a mortgage or a student loan while enrolled in a DMP, you can probably apply for new credit easily enough. But if you emerge from a DMP with no open accounts and a low credit score, you may have to look for “second chance” or “credit building” cards.

Try to open a card with low or no fees. The interest rate is less important as long as you commit to paying your balance in full every month. (If you can’t commit to doing this, address your spending problem before applying for new credit.) Pay your balances on time and in full every month and watch your credit score increase steadily.

Caution: dropping out can harm credit

Enrolling in a DMP can give you some breathing room and help you afford your credit card payments. However, many plans are not affordable for truly troubled consumers — the interest rate and payment reductions are not significant enough to provide major relief.

The Federal Trade Commission (FTC) states that only 21% of consumers successfully complete debt management plans, explaining,

“… it appears that only consumers with considerable disposable income left over each month are able to get out of debt through a DMP.”

In addition, says the agency, when consumers can’t significantly lower the amount that they owe,

“They’re more likely to fail in completing a three to five-year DMP.” 

If you miss your DMP payment or pay more than 30 days late even once, you could have multiple creditors all reporting you late. Even worse, your creditors could decide to stop cooperating with your credit counselor and demand full monthly payments from you. Flunking out of debt management could leave you vulnerable to aggressive collection efforts from credit card companies.

Be very careful when a counselor evaluates you for a DMP, and look into alternatives like bankruptcy or debt settlement if your payment isn’t affordable. DMPs can be useful for getting out of debt, but they don’t work for everyone.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

Gina Freeman
Gina has been writing consumer-centric content in the personal finance, business and investing for nearly 20 years. She loves making challenging or even “boring” topics accessible and helping readers feel educated and confident in their decisions.

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