Does debt management affect your credit score?

While debt management can be a helpful tool to get debt under control, it can negatively affect your credit score.

Hard inquiries

A hard inquiry may happen at some points in debt management. For example, if you attempt to get a lower interest rate, you may trigger a hard inquiry into your credit report. Hard inquiries stay on your credit report for two years and can impact your credit score for one year.

However, this is a short-term effect and can easily be countered by other factors. For example, if you can get your rate lowered, and this means you’re able to pay your monthly bill consistently, you’ll see a positive effect on your payment history, which makes up 35 percent of how your credit score is calculated.

Missed payments

While consistent payments will positively affect payment history, missing payments will cause your credit score to lower significantly. If you, or your credit counselor, are using a tactic of withholding payment from your creditor to get a better rate, expect your credit score to go down.

Credit utilization

Another key factor in the health of your credit score is your credit utilization. This factor makes up 30 percent of your calculated score and is linked to how much debt you carry compared to your available credit. The ideal credit utilization is between 10 and 30 percent. This means that your debt should equal no more than 30 percent of your available credit across all accounts.

Having all your debt consolidated into one bill can be beneficial for paying things off.  However, if you close some of your accounts, you’ll affect your credit mix, which makes up 10 percent of your credit score, and your credit history, which accounts for 15 percent.

Other financing options to handle debt

When thinking about how you will handle your debt, choose the best option for your current financial situation. Debt management is one way to handle debt, other options are worth considering.

Balance transfer credit cards

Balance transfer cards can offer you the ability to move your debt to a zero percent introductory interest card. This will give you the option to pay off your debt without having to worry about interest. Balance transfer cards do, however, come with fees, including a fee for each balance transfer in most cases. If you are not moving your balance to a preapproved card, you may have a hard inquiry on your credit report.

Balance transfer cards are available if your credit score is in the good-to-excellent range but may not be available if your score is in a lower range. You’ll also need a clear plan for repaying your debt before the zero percent interest period ends. You’ll then be subject to the regular variable APR on any remaining balance.

Personal loans

Personal loans allow you to receive a lump sum of money that can pay off your debt all at once. A personal loan is a good option if you know that you will need more time to get your debt under control. Personal loans will offer a repayment period that typically ranges from two to seven years. Unlike a credit card, you will have to repay your loan by the end of the specified period.

Your interest rate for a personal loan will depend on your credit score. Interest rates for personal loans can range from 5 to 36 percent, so make sure that the rate you receive is lower than the rate you are currently paying on your outstanding debt. Bankrate has a tool that can estimate your interest rate for some of the top personal loans on the market.

Is debt management right for you?

Debt management can be a helpful tool for releasing debt, but it isn’t a magic bullet. Debt management does not address secured debts like mortgages.

Note that debt management doesn’t stop your bills from coming. For debt management to work, you must have enough income to cover your existing bills.

A debt management counselor may be able to negotiate a lower monthly payment or interest rate, but the bills will still have to be paid regularly. And missing a bill is not a great option. Not only will it hurt your credit score, but it may also cause your creditor to cancel your negotiated repayment plan. This will leave you back at square one with your debt.

Noteworthy:

It can be overwhelming to manage debt, and finding a solution to get rid of it is often even more challenging. Fortunately, debt management options, like the debt snowball, debt avalanche, DMPs and debt settlement, can help you get the relief you need and deserve.

They’re not all created equal, though, as some strategies have more long-lasting adverse effects than others. You may also find another financing option, like a balance transfer credit card or personal loan is more suitable. Weigh the benefits and drawbacks of each debt management method to make an informed decision that helps you meet your debt-payoff goal in record time and works best for your financial situation.