Does Credit Repair or Debt Management Hurt Credit Ratings?

Americans have a history of woes with consumer debt, so it's no surprise there are so many ads for credit repair services. We owe more than $14 billion on loans, credit cards, mortgages, student loans and vehicle loans. Last July, the Huffington Post reported that 35 percent of Americans with credit records had bills reported for collection. For many, credit counseling and a debt management plan (DMP) can head off real disasters like bankruptcy or foreclosure. However, these strategies are not without their drawbacks.

What Is a Debt Management Plan?

Entering a debt management plan means working with a credit counselor, who contacts your unsecured creditors and negotiates a more affordable payment for you. Your interest rate may be lowered, and fees and penalties may be waived. You make a single monthly payment to the plan and the counselor distributes it among your creditors. Most people who stick with their plans get out from under their balances within five years. Sometimes, a debt consolidation loan, which pays off higher-interest accounts and replaces them with a single lower-interest loan, is part of this plan.

Debt management is not debt settlement, which involves withholding payment from your creditors and dodging their calls, while you save up a lump sum of cash. The idea is to wear down the creditors until they become willing to accept a smaller sum as payment in full for your accounts. There is a lot that can go wrong with such a plan.

Benefits and Drawbacks of Debt Management Plans

Debt management can be smart, and undertaking a debt management plan is not always a last-resort measure. It can spare you months if not years of cascading credit scores and collection hell fire. A good DMP through a reputable credit counseling service can reduce your payments and interest rates, provide budgeting assistance and help you rein in your spending.

But what are the negative ramifications? There's the possibility of ending up in court, ruining your credit, or losing a lot of money if you're not careful. Exercise caution and diligence in choosing a debt relief service. Some people mistakenly end up trying a "debt settlement" scheme, taking out a debt consolidation loan they can't afford, or paying thousands for so-called credit repair they could do themselves for free.

Another possible drawback is that, depending on how your creditors report your payments under the plan, your credit score could take a hit. Some creditors report DMP payments as "not as agreed," which can be harmful. Others do not. Sometimes the plan shows up in your credit report, and other times it doesn't. However, public and non-profit agencies that counsel consumers on credit repair options are among the first to say that having a debt management plan documented in your credit history is far superior to having a bankruptcy.

Finally, many people who use debt consolidation loans as part of their debt management plan end up in worse shape because they don't stop overspending -- they pay the credit cards off with a debt consolidation loan, but then they run their balances right back up. Debt consolidation just moves debt from one account to another (hopefully with better terms, so you can pay it off faster), but you still owe the money. There's no getting around that.

Credit Repair and Credit Counseling

You can get good results with the right help. The Federal Trade Commission (FTC) offers free assistance and links to non-profit debt relief and counseling organizations.

People who owe staggering balances on consumer debt are often unwilling to admit that they need credit counseling. That's like saying the iceberg wasn't so bad and they'll captain the ship the rest of the way. Repairing credit should not be a self-help endeavor. Credit counseling offers you a clear, unemotional assessment of your woes, rolling out an assortment of credit repair tools like debt management plans without pressure. Counselors can also help you contact credit bureaus and correct any errors that could be lowering your score.

A good plan should include budgeting advice and counseling to prevent future over-spending. Your counselor may be able to solve some problems with a quick call to your creditors -- for example, getting them to "re-age" your account, which means ignoring a missed payment and reporting your account as current (not requiring you to make up a missed payment).

Sometimes, all you need is a simple debt consolidation loan to lower the interest expense and help you speed up your debt repayment. Increasing your available credit and paying down your balances over time will repair your credit score.

The Bottom Line

The main points to remember if you're seeking to improve your credit score and reduce your debt are these:

  • Be careful choosing a credit counselor and / or debt management plan. Work with firms on the FTC's list.
  • Debt settlement and debt management are not the same thing. Avoid debt settlement at all costs.
  • Debt management can cause your credit score to drop at first. However, successful completion of a plan increases your financial health and your scores will reflect that.
  • Do not undertake a debt consolidation loan until you have your spending under control.
  • Credit restoration takes time. Don't fall for claims of "instant" credit repair.

Credit counselors can give you the education, tools and support needed to break free of your debts. Any small hit to your credit score is probably temporary and probably worth accepting.

Credit Scores are totally free!