Does Credit Counseling Have a Negative Impact on Your Credit?

A licensed credit counselor is trained to work with an individual's creditors to help reduce balances, interest rates and fees while teaching him valuable debt management skills. Although credit counseling can relieve a consumer's stress and help him prevent bankruptcy, evidence of the credit counseling program will appear on his credit report.

Significance

When negotiating with creditors, a credit counseling agency will enroll a debtor into a debt management plan. Debt management plans are tailored to fit the financial needs of each consumer. Should a creditor agree to work with the credit counseling agency and permit the debtor to make payments in accordance with her debt management plan, the creditor will report to the credit bureaus that the account is being paid through a credit counseling program. The notation then appears on the individual's credit report. Credit counseling notations are not included in the FICO scoring formula and thus have no impact whatsoever on credit scores.

Time Frame

The majority of information that appears on consumer credit reports, such as accounts, payment histories, judgments and charge-offs, appears for seven years. This allows a lender reviewing an individual's credit record to evaluate his past credit history in addition to his current debts. As soon as a debtor completes credit counseling or opts out of the program, the debt management plan ends and evidence that the individual sought the aid of a credit counselor will disappear from his credit report.

Misconceptions

A particularly strong myth about credit counseling is that evidence of credit counseling on an individual's credit report negatively impacts her credit score to the same degree as a bankruptcy. While credit counseling notations have no direct effect on credit scores, lenders may frown upon the fact that a debtor needs the help of a credit counseling agency to pay her debts. An individual's participation in a debt management plan may suggest to a lender that the consumer cannot successfully manage and repay debt on his own--making him a higher lending risk regardless of his credit score. Bankruptcy, however, is always much worse for an individual's credit than credit counseling.

Considerations

Credit damage through credit counseling can occur if the credit counseling agency negotiates a debt settlement with an individual's creditors. Settling a debt for less than the full balance can lower credit scores. In addition, some creditors refuse to consider a delinquent debt "current" until the individual makes a certain number of timely payments under his debt management plan. This can also damage credit scores. The credit counseling agency is only responsible for helping the debtor repay his creditors. It cannot control how the creditors choose to report the individual's accounts to the credit bureaus.

Warning

According to the Federal Trade Commission, some debt settlement firms advertise themselves as credit counseling agencies to attract new clients. Debt settlement companies often require debtors to make payments to the company rather than their creditors. Rather than distributing the payments to pay off the individual's debt, however, the debt settlement firm holds onto the money--causing the debtor's account to go delinquent. The goal is to lead the creditor to believe that it must settle to receive payment. In the process, however, the debtor's credit rating suffers significant damage.