How Credit Counseling Affects Your Credit Score
Trying to figure out how different financial moves will affect your credit score can feel like a guessing game. If you’re feeling held back financially by your debt or credit history, it might be helpful to work with a credit counselor who can provide you with specific steps to improve your credit score. But everyone’s experience will be different, and credit counseling doesn’t always yield immediate results.
How credit counseling impacts credit
Credit counseling is a service, often given free of charge by nonprofit organizations, that provides consumers with credit-related guidance. Credit counselors typically begin with a credit report review which includes pulling your credit report, explaining how to read it and answering any questions you have. After that, they may also offer debt help, which involves going over your budget and recommending the best debt repayment option for you, which may include a debt management plan, debt consolidation loans, debt settlement or bankruptcy depending on your situation.
McKenzie Walsh, a certified financial counselor at the nonprofit AAA Fair Credit Foundation, first shows her clients how to pull a free credit report and then helps them lay out a plan of action for improving their credit, which includes short-term solutions, such as disputing inaccurate information, and long-term solutions, such as paying off high balances. If you’re worried about the impact these actions might have on your credit, Walsh said you shouldn’t be. “When you seek out a credit counselor,” she explained, “your credit score is most likely only going to go up as long as you follow the advice being given.”
You should know that credit counseling itself will not have a direct effect on your credit score. The credit counselor doesn’t report their activity to the credit bureaus if they are offering simple counsel and advice.
That being said, any action you take as a result of your credit counselor’s guidance has the potential to affect your score. How quickly your score will improve will be different for each person. If your credit history is riddled with negative activity, it could take months or years for that negative history to fall off your report and your new positive history to outweigh it.
Credit counseling vs. debt management plans
While credit counseling itself won’t directly impact your score, signing up for a credit counselor’s debt management plan might.
Credit counselors often offer debt management plans as part of their services, and these programs can cause your credit score to take a temporary hit.
With a DMP, credit counselors will try to negotiate your interest rates and repayment amounts with creditors and outline a payment plan for you. The repayment process is often simplified — your credit counselor will accept one monthly payment from you and disburse that payment to the appropriate creditors until your debt is paid off.
If your credit counselor is able to negotiate a lower repayment amount, the account will show up on your credit report as a “settled account,” and you could see a decrease in your score.
Also, some credit counselors will close your accounts if you’re in a debt management plan so that you can focus on paying back your debts. Martin Lynch, director of education and compliance manager at Cambridge Credit Counseling, said it’s common for this to cause an initial drop in his clients’ credit scores. His average client loses about 19 points in the first month, he told LendingTree. The hope is that a temporary drop in score will be worth it in the long haul and that scores will increase once the debt management plan is completed.
If you choose to go through a debt management program, a note indicating this will be added to your credit report. This is a neutral mark, and according to Lynch, it won’t change your credit score. That said, future lenders will be able to see this mark on your credit history. While “their interpretation is anyone’s guess,” he conceded that some might see it as a negative.
It’s important to note that there’s a difference between credit counseling and debt consolidation. A credit counselor who offers debt management plans will help you consolidate your payments by acting as an intermediary, while debt consolidation is when you consolidate your debt by taking out a new loan or credit card and using it to pay off your existing debts. In some situations, debt consolidation might be a better option than a debt management plan.
Debt management plans are designed for people who don’t have the money to pay off their debt, so they often involve slower repayment. Lynch advised against entering into a debt management plan with a credit counselor if you have the financial ability to meet your monthly payments already. The best thing you can do for your credit score and your wallet is to pay those debts off in full as quickly as possible, and consolidating your debt at a lower interest rate can help you do that.
Where to get credit counseling
Do your research and look for reputable credit counseling organizations with the proper licensing. According to the Federal Trade Commission (FTC), most credit counseling services are nonprofit. The FTC recommended looking for in-person credit counseling whenever possible. You might be able to find nonprofit credit counseling at your local university, credit union, housing authority, military base or U.S. Cooperative Extension Service branch.
The National Foundation for Credit Counseling (NFCC) is also a great place to start. It’s the largest and longest-running nonprofit financial counseling organization in the country, and it can connect you with one of its many NFCC-certified credit counselors for free.
What to beware of when seeking credit counseling
Scammers often target people in financially vulnerable situations, so seeking credit counseling can put you on their radar. Fortunately, they’re easy to avoid if you know what to look for.
Watch out for these red flags when dealing with organizations that offer credit counseling and credit repair:
- They ask for upfront payment before they’ve done any work.
- They make unrealistic promises, such as guaranteeing a certain jump in your credit score or amount of debt forgiven.
- They can’t answer your questions or explain the specifics of what they’re doing.
- They hold back information or actively misinform you.
- They ask you to lie or misrepresent information.
Walsh said that following the old adage of “if it’s too good to be true, it probably is” will help you steer clear of illegitimate services. Remember that improving your credit will take time, and no one can make specific promises about the results you’ll see. For example, if an organization tells you they can increase your credit score by 50 points in six months, they probably shouldn’t be trusted. “We know what impacts a credit score,” she said, “but we don’t know the credit algorithm.”
You should also watch out for companies that try to enroll you in a debt management plan right off the bat before offering you any financial education. According to Lynch, credit counselors should be looking at your income and expenses and helping you to set up a budget well before they start selling programs to you. He also said to be wary of debt settlement companies that portray themselves as credit counselors. The two services are different, and debt settlement doesn’t involve counseling or any attempt to improve your credit.
Credit repair vs. credit counseling
Credit repair is another service that might sound like credit counseling but actually offers something quite different. While credit counseling is typically free, credit repair agencies charge a fee, and they often promise to remove negative marks from your credit report. Remember, if a mark on your credit report is accurate, the credit bureaus won’t remove it. If you do have inaccurate marks on your credit report, you can dispute them yourself. Credit repair agencies have no special ability to remove marks from your credit report. Walsh explained that credit counseling is more about educating you and giving you tasks to complete yourself, whereas credit repair agencies will take action on their own.
Walsh always tells her clients not to pay for something they could do themselves. “Make sure that you’re aware of the power you have to make a change before hiring a third-party to do something that might not even take effect,” she said.
Credit counseling won’t hurt your credit score. And while the actions you ultimately take as a result of that counseling might bring your score down a bit, taking control of your finances and paying off your debt will far outweigh any temporary dings to your credit. As Lynch explained, if you’re struggling with debt, “your credit score is already compromised.” Your priority shouldn’t be avoiding the loss of a few more points. It should be paying off your debt. Doing so will help both your credit score and your wallet in the long run.