Will Credit Counseling Hurt Your Credit Score?

Agencies like Cambridge speak to thousands of people every month, and one of the most common questions we hear is, “Will credit counseling hurt my credit score?” The short answer is no, but that comes with an explanation.  “Credit counseling” is the process by which a certified credit counselor will help you create a workable financial plan that reflects your income, expenses, and goals.  Your counselor will review your finances with you, give you personalized advice to help you develop a budget, provide valuable resources you can use in that process, and recommend alternative strategies to manage your situation.  This type of free consultation has no impact whatsoever on your credit standing.  Now, one of the options a counselor may offer is enrollment in a debt management program, or DMP. A debt management program will impact your credit, but probably not in the way you may be thinking.

Your credit scores, or “FICO scores,” are calculated from the data in your credit report at any given moment. That’s why they often change from month to month, as your creditors report your activity. The data is grouped into five categories: Payment History, which represents 35% of your score; Amounts Owed, which is 30% of your score; Length of Credit History – 15%, New Credit, 10%; and Types of Credit Used, which also accounts for 10% of your FICO score. The importance of any one factor depends on the total amount of information in your credit report at that moment.  This means that what impacts your score may not impact another person’s score as heavily.  Now, on to the good news.

Fair Isaac and Company, developers of the FICO scoring model, considers debt management enrollment as a neutral mark – neither good nor bad, and it carries no weight when calculating your score.  This wasn’t always true.  In 1989 debt management was considered a negative notation; however, the formula changed in 1998 because people were enrolling in DMPs as a proactive step. Instead of looking for help after they fell behind on their bills, people were reaching out to credit counseling agencies before things got out of hand.  So if the creditors you include on your program note that your account is being repaid through a reduced payment and interest program, you won’t lose any points as a result of that notation. However, each of your prospective lenders has its own policies. One may view debt management as a non-issue, while others may interpret it negatively. There’s simply no way to predict that reaction.

Although participation in a debt management program isn’t a factor in FICO’s formula, the process of enrollment will affect your score.  In a DMP, your credit counseling agency pays your bills once each month, and many creditors drastically reduce their interest rates and waive their late and overlimit fees.  In return for those benefits, they require that the accounts you include in your plan be closed. That’s reasonable. Now, closing those accounts lowers your score because the amount of available credit is reduced, and that’s a part of the Amounts Owed category.  The number of points you lose depends on the other information in your credit profile at that time.  If you have a good credit history, with a lot of accounts in good standing, you may lose just a few points.  If you only have a few accounts, the impact may be greater.

At the time you enroll, the agency will let your creditors know when your payment will be disbursed; however, as you transition into the program, you could experience a late or missed payment.  That would impact your score, but the length of the program, generally 3 to 5 years, gives you more than enough time to make up for that initial event.  It’s also important to remember that even though participation in a DMP is a neutral mark, it doesn’t “protect” you from incurring a negative notation, either.  Just like when you’re managing your bills on your own, if you miss a payment on one of your accounts, your history will be affected.  That’s one of the things you’ll learn while you’re working with an agency. You’re not just a number to us – we want to show you how to earn lower interest rates by developing good credit habits. Making payments on time is one of them.

If you pull your own credit report or review your score through a free website like CreditKarma.com, which I highly recommend, you may discover that you have too much debt. For example, if all of the credit limits on your accounts added up to $10,000, and all of the balances on those accounts added up to $5,000, you’d be using 50% of your available credit. On creditkarma.com, you’d see a note like “proportion of balances to credit limits is too high on revolving bank accounts,” which means that your score has already been impacted negatively. In fact, if you’re using more than just 30% of your available credit, you may already be damaging your score.

In situations like these, when interest rates and balances are both so high that it would take more than five years to repay your debts, it’s worth your time to call a counselor and find out if a debt management program could help you. At Cambridge, our DMPs help people get back on track, allowing our typical client to pay down their balances much faster and saving them plenty in interest.  With less debt, and a budget that puts money into savings every month, you could also position yourself as a good lending candidate in the future.  Until next time, I’m Thomas Fox for Cambridge Credit Counseling.

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