How Do Debt Consolidation Programs Affect Credit?

If your mailbox is brimming with bills for debts that you're unable to repay, there's a chance that debt consolidation programs can help alleviate some of the stress and financial burden associated with out-of-control debt. Make no mistake though, debt consolidation programs can negatively affect credit in some instances, at least in the short term.

Definition

Debt consolidation programs help consumers struggling to make large, multiple payments on debts streamline finances by consolidating obligations, sometimes at a discount. Through a debt management plan, consumers make a monthly payment to a credit counseling organization. Lump payments are dispersed by the organization to the consumer's multiple creditors for things like student loans, medical bills and credit card payments according to a negotiated repayment schedule. This may result in waived fees or lowered interest rates, since creditors may feel more confident doing business with a debt consolidation specialist than an unreliable consumer with a shaky payment history.

Short Term

Although visiting a debt consolidation program counselor to discuss your options won't affect your credit, following their suggestions and guidelines will often result in a short-term negative impact for your credit. Lenders view debt consolidation efforts as a signal that a consumer is struggling to manage credit effectively. This may already be obvious and have negatively impacted your credit through late payments, missed payments or accounts turned over to collection agencies.

Long Term

When managed effectively, debt consolidation programs can have a long-term positive effect if you're able to successfully make regular on-time payments, pay down debt with the help of waived fees and lower interest rates, avoid having accounts turned over to collection agencies and avoid filing for bankruptcy. However, missing payments that have been negotiated and arranged through debt consolidation programs can worsen your credit, because lenders have already given you a second chance and may require that accounts be closed, lessening the amount of available credit. Paying down debt without addressing underlying issues concerning spending habits or budgeting could land you back in the same indebted situation, facing another credit landslide.

Caution

Legitimate groups offering debt consolidation programs hire counselors who are trained and certified to help consumers address debt challenges with education and resources related to consumer credit, money managing and budgeting. Some unscrupulous companies misrepresent their fee scales or encourage consumers to enter debt consolidation programs without fully understanding or presenting a complete menu of options, according to the Federal Trade Commission. When first making payments through your credit counseling agencies, check with lenders to make sure payments are being received and credited to your account before continuing to make payments. Otherwise, you could be hurting your credit when these well-intended payments are misdirected into fraudulent accounts.