You’re considering a debt management program to get relief from excessive debt payments. While it’s a viable option to pay down your outstanding balances and free up funds in your spending plan, you are probably wondering how a debt management program will affect your credit score?
That’s a reasonable question to consider, along with the benefits and drawbacks of these programs. Read on to learn more about how they work, the potential impact on your credit health, and pros and cons to be mindful of before enrolling.
What is a Debt Management Program?
Also known as a debt management plan (DMP), a debt management program helps consumers get a handle on their unsecured debt balances. It can be used to tackle credit cards, retail store cards, personal loans, payday loans (in some cases), and other unsecured debt and generally lasts between 36 and 60 months. However, mortgages, auto loans, and other debts secured by collateral aren’t eligible for inclusion in a plan. You also won’t be able to include student loans.
Before enrolling in a DMP, you’ll have to complete a credit counseling session to determine if it’s a good fit. During the meeting, the credit counselor will assess your financial and credit health and educate you on all the available options to help you alleviate overwhelming debt.
If you decide to move forward with a DMP, the credit counselor will create a modified repayment plan that works for your budget. They will also contact your creditors to notify them of the DMP, negotiate concessions and get their plan’s approval.
You will pay the credit counseling agency the agreed-upon payment amount each month. They will divide the funds between the creditors, per the modified repayment plan, until debts under the DMP are paid in full.
Please note that your monthly payment will stay the same for the plan’s duration, even as you pay off balances. The credit counseling agency will simply pay the other creditors more until you reach the finish line.
But if you experience financial hardship and can no longer afford the monthly payment, you could be removed from the program.
How Does A Debt Management Program Affect Your Credit Score?
You’ll typically be asked to agree to a soft credit check when you sign up for credit counseling so your counselor can analyze your credit profile. However, a soft credit check won’t impact your credit score.
But if your credit card issuers agree to a modified repayment plan, they could close your accounts. Consequently, your utilization will increase and could hurt your credit score. The good news is your accounts could be brought current if the creditor agrees to re-age them. Plus, your payment history, which is the most significant component of your credit score, will improve as you continue to make timely monthly payments.
What Are the Benefits of a Debt Management Program?
Before enrolling in a DMP, consider these key benefits:
- Consolidate your monthly payments: A DMP streamlines the repayment process by allowing you to make a single payment each month. You won’t have to worry about paying several creditors or missing due dates. The amount you’ll may also be lower than what you were paying before enrolling in the program.
- Get out of debt faster: The credit counseling agency could negotiate valuable concessions with your creditors, like a reduced interest rate or the removal of late fees and re-aging of your account, to help you reach the finish line in three to five years. You could also save a sizable amount in interest.
- Preserve your credit health: Your credit score could take a hit when you initially enroll. But it’ll typically improve over time as you pay down your balances. And a DMP is far less harmful than debt settlement and bankruptcy – both linger on your credit report for several years and have negative long-term consequences.
- Stop collection calls: If you’re behind on payments and the account is enrolled in a DMP, the collection calls will cease as the creditor starts to receive payments from the credit counseling agency on your behalf.
What Are the Disadvantages of a Debt Management Program
Unfortunately, there are also drawbacks to be mindful of:
- Monthly fees for enrolled debt: You’ll pay around $50 to enroll in a DMP, and there are monthly fees between $20 and $30 per enrolled account. However, the enrollment fee and monthly fees are rolled into your program payments, so you won’t pay anything upfront or separate from the program payments.
- Limits access to credit: The credit card issuers will freeze your accounts, you won’t have access to those credit cards. You cannot open new credit cards while you are enrolled. In many plans, you’ll be able to keep one or two credit cards active, so you have access to some credit.
- Risk of termination: You could also be removed from the program if you miss monthly payments.
