Part of the reason you use a debt management plan (DMP) to overcome credit card debt over other solutions is that it minimizes credit damage. Unlike debt settlement or bankruptcy, using this type of program won’t create negative remarks in your credit report. However it does influence your credit score and that influence can be good or bad, depending on where you started. This guide explains why.
Debt management and your credit report
Some debt solutions are noted in your credit report. Bankruptcy creates a public record that sticks around for 7-10 years. Debts settled through a debt settlement program are noted as “settled in full,” which is also noted for 7 years.
Debt management doesn’t have any negative notation. As long as the program is set up correctly and you make the payments on time, there will be no negative remarks on your credit report.
Debts paid through a debt management plan will be noted as “paid in full,” which is what you want.
Why a DMP’s credit score impact can be positive or negative
There are five factors used to calculate credit scores, including FICO and VantageScore. Each factor has a different “weight” for how much in impacts your final score.
- Account history 35%
- Credit utilization 30%
- Credit age 15%
- New applications 10%
- Credit mix 10%
A debt management plan has positive effects on some factors, particularly the biggest factor. The program helps you build a positive payment history on each account you include.
At the same time, the program has some negative effects on other factors, but mostly minor ones. The biggest negative impact comes from having to close your accounts. However, since the factors that effects don’t carry as much weight, the negatives can often be outweighed by the positives.
If your score is low when you start a debt management plan, the program will usually have a positive impact.
On the other hand, if your score is extremely high when you start the program, then you may see your score drop slightly when you complete the program. In this case, you may want to consider other options, such as a debt consolidation loan.
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How debt management affects the 5 scoring factors
A DMP should almost always be positive for payment history.
Any payment missed by more than 30 days will be noted in your credit report for seven years. Making payments on time is also noted.
- A DMP helps you build positive payment history.
- Each payment you make on-time will be noted in the payment history of each account you enrolled.
- It also helps you bring delinquent accounts current.
Recent history is more important the what happened in the past. This means you can offset passed missed payments by completing a DMP, making somewhere between 36-60 payments on time.
All this is extremely positive for a factor that’s worth more than a third of your credit score.
How the plan will affect this factor depends on your situation.
Credit utilization can be tricky to understand and even more difficult to know exactly how it applies.
Utilization measures your current balances versus your current available credit limit. If you owe $500 on a credit card with a $2,000 limit, your utilization is 25%. Anything more than 30% is bad and less is always better.
The factor looks at both total utilization ratio overall, as well as the ratio on each account.
As you make payments through the program, the balance on each account gradually drops to zero. However, as you pay off each account, it closes, which drops your credit limit.
If you include all your credit cards in the program, then you won’t have any balances, but you won’t have any limits either. As long as you rebuild your credit properly, you can keep your utilization ratio low.
TIP: If you leave a credit card out of the program for emergencies, make sure it has a low balance and keep it that way. Otherwise, if you’re using more than 30% of the limit, you may see more notable score damage from a DMP.
Credit age may decrease as you complete a DMP.
This factor measures the average age of your accounts. An older credit age is good because it shows you have more experience using credit.
Closing old credit card accounts can decrease your credit age. The more old accounts you close, the more of an impact you may see. But it also depends on the age of other accounts, such as loans. If you’ve had a mortgage for 10 years and a car loan for 6, then the impact will be less than if you only have credit cards.
You’re likely to have less applications, which is a good thing.
Each time you apply for a credit card, it creates a hard inquiry on your credit report. Each inquiry drops your score a few points, usually less than five.
This point decrease gradually goes away after about six months.
You can’t apply for new credit cards while you’re enrolled in a debt management plan. So, for 3-5 years (on average) you won’t have any new credit card applications on your file.
You can still apply for loans, but most of us aren’t taking out multiple mortgages or car loans in a year. Thus, going through a DMP should have a positive impact on this factor.
The program’s effect on this factor depends on your situation.
The last scoring factor looks at the types of accounts that you have. Creditors like to see a diverse mix of different types of credit. Being able to manage a mortgage, car loan, student loans and credit cards all at once means you’re a lower credit risk.
If you include all of your credit cards in a debt management program, then you may negatively influence this factor. However, this can be easily remedied by opening a new credit card, if you choose once you graduate.
It’s also worth noting that you can have a good credit score without having any credit cards. If you decide to swear off credit cards forever, you can still have a good or even excellent score.
Tips for maintaining your score through a DMP
- If possible, make your minimum payments until your program officially starts. While the credit counseling agency is talking to your creditors, you’ll need to continue making payments to avoid missed payments before your first plan payment.
- Choose a reputable credit counseling agency. Once your payments start, it will be up to the credit counseling agency to distribute the money on time. Only work with a reputable, well-rated agency to avoid getting popped for a bad agency’s mistake.
- If you keep a card out, make sure it’s an old account in good standing with a low balance. This will make it easier to maintain your score as you complete the program.
- Don’t go crazy with credit applications once you finish. Space new credit applications out by at least six months.
- If you decide to quit credit cards for good, find other ways to build credit. You don’t need credit cards to achieve better credit. In fact, some loans were designed for building credit.
Connect with a certified credit counselor to see if debt management is right for you.
Article last modified on April 29, 2020. Published by Debt.com, LLC