Many consumers turn to a debt management program when high credit card balances, fees and interest charges are breaking the bank. Debt management can take many forms, including credit counseling, debt consolidation loans, debt settlement programs, declaring bankruptcy and even making your own commitment to properly budget and take control of your debt. Each approach has its own set of impacts on your credit report and FICO score. Let's take a look at each solution and what effects you can expect each to have on your creditworthiness.
Credit Counseling
In credit counseling, a designated third party typically has existing agreements with creditors. These agreements call for fee waivers and significantly reduced interest rates for accounts accepted into the program. The credit counseling group collects payments from you and disburses to creditors, tracks progress and provides financial education to its clients. Although the creditors accepting your participation in credit counseling may make a note on your credit report of this, enrolling in a debt management program has no immediate negative impact on your credit score. Your credit score, however, may be negatively impacted when creditors on the program close your account, which is often a prerequisite for participating in the program. With less credit available, your debt utilization ratio will rise, which can knock your score down several points. Additionally, you may be unable to apply for new credit during this time--your creditors accepting your accounts will often require this. Also, understanding this obligation, new creditors may reject your applications based on your participation in a credit counseling program. On the bright side, paying your monthly payments on time each month and reducing your debt load will have positive impacts on your credit score.
Debt Consolidation Loan
In a debt consolidation loan, you take out a single loan from a single source to cover all of your outstanding unsecured debt. These loans usually have a lower interest rate than your credit cards and come with a single monthly payment. Effectively, this is a new loan. Like credit counseling, there will be little immediate change to your credit score for taking out a debt consolidation loan--it simply looks like a new line of credit. Over time, if you do not re-load your credit cards and make your payments on time, having a debt consolidation loan can positively impact your creditworthiness. However, your credit score can suffer greatly if you re-load your paid-off credit cards. This can raise your debt utilization ratio and put you at risk for paying late as your monthly obligations rise. Even if you are on time with your consolidation loan payments and do not use your old credit cards at all, your old creditors may simply close your accounts due to nonactivity. This, in turn, lowers your available credit and will also increase your debt utilization ratio. However, over the long term with good payment history with your new loan, your credit score will improve.
Debt Settlement
Debt settlement involves the negotiation with creditors to accept a lower balance versus what is owed on your credit card to end the relationship. This can be done yourself or by hiring a third party. There is no doubt you can save a great deal of money--settlements are often 40 to 60 percent of the outstanding balance. However, part of the process involves being delinquent on your accounts for 90, 120 or more days--these delinquencies will significantly impair your credit score and credit worthiness. When the settlement is offered, your creditor will likely report your account as settled to the credit bureaus. These are essentially charge-offs, and a single instance can lower your credit score by 30 to 100 points, depending on your previous credit history.
Bankruptcy
Bankruptcy is also an option to mounting debt loads. This is a formal plan as decided in court and takes into account your outstanding debts, earnings and assets. A bankruptcy plan provides the consumer with a chance to pay off outstanding debts in accordance with a court-ordered schedule. Depending on the situation, some debts may be extinguished in full without payment. When bankruptcy is declared, expect a drastic negative impact to your credit score. A bankruptcy filing can remain on your credit report for seven years and some individual creditors may never remove this note from their internal records as you still owe the funds. Bankruptcy can reduce your credit score by 50, 100 or even more points and make it nearly impossible to obtain a loan in the near term. After bankruptcy, provided you make an effort to pay bills on time and use credit wisely, your credit worthiness can ultimately recover.
Get Back on Track Yourself
It takes discipline and budgeting, but you can tackle your debt problems with a plan of your own rather than rely on third parties or dire legal actions to get you out from under your debts. Many advocate this as the responsible way--establish a budget, save, start spending less and start paying as much as you can each month towards your outstanding debts--and pay on time. If you are up to your eyeballs in debt, your credit score may not be suffering much at this time with the exception of high debt utilization ratios. If you can turn the tide on your finances before you start making payments late and getting hit with high fees and penalty interest rates, your credit score can benefit immensely. Plus, you will avoid any headache of having third-party comments or notes from the methods mentioned previously appear on your credit report.
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