6/6/2013 6:15 PM ET|
Escaping debt can hurt your credit
Debt relief solutions like credit counseling or bankruptcy will sting your credit score at first, but you may be surprised at how quickly it recovers.
A common concern you may have when searching for the best debt relief solution is how it will impact your credit score.
There are many misconceptions about credit reports and the harm that comes from credit counseling, settling debt for less than what you owe and bankruptcy.
Your credit report and credit score will heal and bounce back over time, and you may even be surprised by how quickly your financial future looks bright again.
First things first: Debt is the priority
If you're considering debt relief options, you're not in a good position to spend, or to be seeking out new credit products -- now or for a couple of years to come.
The three most legitimate debt relief intervention options do indeed impact your credit report and/or credit score. Each method will hurt your ability to get new loans, or certain types of loans, for the near future. That's OK, it's a part of the process. Your credit score should come second to your focus on getting out of debt right now.
I am going to lay out the ways your credit report, credit score, and future access to credit products will be affected by debt relief programs. Each comparison is generalized, but in a way that will help you compare your credit needs for the next three years.
Debt management plans via a credit counseling agency
Your accounts that are accepted into a credit counseling agency's debt management program will be closed. These previously active credit card trade lines will be updated on your credit report to show that the account was closed by the credit grantor (unless they were already closed, or you get proactive and close them yourself prior to enrolling with a credit counseling service). Closing active credit accounts can have a negative impact on your score.
While enrolled in a credit counseling program, it is generally very tough to get financing of virtually any nature in the first 12 to 24 months. This is because many creditors will inform the credit reporting bureaus that your account with them is enrolled in a structured debt repayment plan. Because credit counseling agencies will normally want to have all of your credit card debts enrolled in the plan, this type of reporting will likely appear several times across your credit report.
Debt management programs with credit counseling companies run 4 to 5 years, on average. This can mean you are locked out of new unsecured credit products, like new credit cards, for this entire period of time.
You may be able to get financing on a vehicle or even purchase a home, modify an existing mortgage, or qualify for a student loan (either your own or parental) after the first 1 to 2 years of making on-time payments in the debt management plan.
When you complete the debt management plan, and if all other payments were kept current (like an existing mortgage, student loan, car loan), you should find that your credit score stayed in good shape. You will have eliminated most, if not all of your unsecured debt, after working with the credit counseling agency. But you will have also eliminated years' worth of unsecured credit history, and have no recent unsecured credit activity. Recent credit activity is one of the most important parts of your credit report you'll need to rebuild.
Settling debt for less than you owe
Settling your credit card debt for less than you owe requires you to have missed payments. This fact will give many readers pause if you are still making your payments on time. If you are reading this and are already 90 or more days late, and cannot afford a debt management plan with a credit counseling service, your options for debt relief could be limited to bankruptcy or settling debts.
For those readers who have not missed credit card payments yet, but know that you will soon fall behind, missing payments is how you set yourself up to settle later. However, missing payments will:
- cause your credit score to fall significantly, and
- stain your credit report with late pays and potential charge-offs, and can lead to later debt collection entries for 7 years.
How debt settlement impacts your credit report and credit score will vary widely from one person's situation to the next.
Since another major portion of your credit score is factored on repayment history, your credit is going to take a dip from using this debt relief strategy. The duration of the credit pain will be different for each person. But once you achieve zero balance reporting, your credit score can begin to improve. How long it will take to improve will depend on several factors:
- How long it takes to settle your debts. Settling a credit card debt directly with your lender before the account goes 180 days without payment is best.
- Did your account get sold to a third party who is now reporting a collection entry on your credit report? This means your original lender reports your debt as a charge-off, and the debt collector reports a new entry on top of that.
- What accounts were current during the settlement process? Those who settle credit card debts while keeping current with their payments on a mortgage, car loan and student loans tend to see their credit bounce back quicker.
- Did you have much credit depth before settling debts? Those with paid-off home loans, auto leases and loans, paid-off credit cards, etc., tend to recover faster than someone whose only accounts in their credit profile were the credit cards that got settled.
- Were you able to take smart steps to improve your credit along the way? There are indeed ways to cherry pick accounts you settle, or pre-plan your settlement strategy in order to improve your access to credit products sooner.
In my experience of more than a decade of working with people to resolve debts by settling balances for less, I see peoples' credit scores and access to new credit products recover in 12 to 18 months, on average. This would be a year to a year-and-a-half after the last account gets settled and the credit reports are updated to reflect that there is no longer any balance owed. By "recover," I mean you are in decent credit shape again in order to qualify for home loans, auto leases and loans, and even new credit cards.
I have worked with people who, after completing settlements, have been able to get Federal Housing Administration underwriting on a home loan, funding for student loans and new auto financing much earlier than would have been the case had they filed chapter 13 bankruptcy, or enrolled with a credit counseling agency.
A key factor for bouncing back from settling debts and accessing new credit comes from a healthier debt-to-income ratio. Your finances now reflect that you can take on new debt and successfully make payments with your income.
More from Credit.com:
MORE ON MSN MONEY
VIDEO ON MSN MONEY
...News Flash - getting into debt can hurt your life!!
Banks, and Corporate America have been selling us this ME-MORE-NOW nonsense for decades - remember - when the slaves are indebted to the owners of the means of productions - they own you. The slaves leg irons of long ago have been replaced with debt and interest payments. Going into debt benefits only the Banks and Corporate America.
The solution: pay off your debt - and learn the difference between need and want!
What a terrible article. Get this folks, if you have a good income and no bad marks on your credit report, you will have no problem with credit.
Debt is BAD. They want you to be in debt so that they can get rich off of the interest you pay. Get out of debt and stay out of debt.
If you can't afford to save up and pay cash for something other than your house, then you can't afford it. Want a new car? Save up for a used one. They payment that you would have paid anyway, pay to yourself. Pretty soon you'll have enough cash to pay for a new or late model used car.
Check out Dave Ramsey.
A LOT of people DON'T GIVE A $HIT ABOUT A CREDIT SCORE.
Bull$hit article. Is the MORON who wrote this article in the pay of the collection agencies??
Bet she is!!
My credit score took a dive due to health reasons and had to retire on social security disability.
At that time none of my creditors wanted to work with me, they each felt that they were my only creditor and didn't care to hear that I was wanting to work out a repayment budget that worked out for all of my creditors.
With my situation here in Texas, all I have to do is wait 7 1/2 years for all my past negative credit to drop off my credit reports. I now only have a few years left before this happens.
I like it when debt collectors call. It gives me a chance to practice my imitation of gorillas having sex.
I've also seen to many people get everything paid off finally, and then turn right around and do it all over again because all the financial advisers keep harping that you need to a credit card or two. Most people seem to equate this as 4-5 and to run them up to the credit line again. The only loan you really need is for a house, maybe a car.
That's YOU if you become enslaved to the system.
The debtor is a slave to the lender.
Responsible credit card use is not tough. Many people handle it every single day.
However---if you can't handle credit cards, that's fine but don't blame credit cards because you cannot handle a simple budget and impulse control.
Copyright © 2013 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.