I Unexpectedly Got Handed a Lot of Money, and That’s Now a Big Problem!

Question: I hired a debt consolidation company to pay down my debt in October. But then something unexpected happened: I came into a lump sum of money.

I can now use that lump sum to pay off my debt completely. Here’s the problem: I’ve already started the process with the debt consolidation company. I’m several months late on my credit card accounts – which is part of the program. That way, they can negotiate down my debt and close the account.

What I’m wanting to know is: Should I pay the money to the debt consolidation company and let them close the accounts? Or should I pay the credit card companies directly and keep the account open? They’re old accounts, and apparently, having old accounts helps my credit score.

My concern is that if these accounts are closed, my debt-to-credit ratio will be bad – and I’ll have to open newer accounts to fix my credit. I want to fix my credit ASAP. So should I pay the creditors directly? Or pay off the debt consolidation company and let them close my accounts for me?
– Melissa in Texas

Howard Dvorkin, CPA responds…

This is going to sound backward, but let’s start at the end of Melissa’s question and work our way to the top.

Melissa closes her question by citing her credit score. In other words, her unexpected windfall means she has enough money to pay off her debts, but she’s not sure which one will help her credit score the most – or which one will sink it faster.

The credit question

Before we decide that, we need to look closer at Melissa’s own words. First, she says, “My concern is that if these accounts are closed, my debt-to-credit ratio will be bad.”

Melissa is correct. What you call debt-to-credit ratio, we call credit utilization. Same thing, different terms. Basically, it means, “How much of your available credit have you already consumed?”

That’s important, because lenders get nervous about lending money to people who, for example, are already maxed out on their credit cards. Lenders want to get paid back one day, with interest. If you’re using up all your credit, that’s a sign you don’t have enough money to meet your obligations.

So what does credit utilization have to do with Melissa’s dilemma? Well, if your accounts have credit still available on them, and you close them, then your credit utilization will indeed look worse.

Melissa also points out – correctly – “They’re old accounts, and apparently, having old accounts helps my credit score.” That’s very true. One other factor for a good credit score is called “credit age.” The longer you’ve had your accounts open, the better you look to a potential lender. The reason is simple: You’ve had a long-term relationship, which shows you’re responsible.

The debt question

Now (finally) we’re onto Melissa’s main question: Should she pay off your debts herself or keep working with the company she hired?

To answer that, I consulted my own expert. David Field runs Sunrise Financial Solutions, a debt-settlement company with impeccable credentials and references.

“If I removed my bias, to pay on their own or through the debt settlement company are both valid options,” David says. But he adds this important difference…

Consumers should know that a debt settlement company is often best equipped to get the lowest possible settlement percentage based on their relationships with the creditors and their understanding of the timing to make the offer.

If Melissa’s company already sent in the proper paperwork, David says her accounts might already be closed.

“She can keep an eye on her credit score once the account is settled in full, just to see if it’s improved,” he says. “My recommendation would be to call the company, get a payoff quote, and take it from there.”