Debt relief refers to strategies that help to manage a growing debt. A debt relief program might affect your credit, but this depends on the plan you choose.
Sure, your credit score may have taken a nosedive because you mismanaged debt, or are undergoing a financial crisis. But you can still change the situation and ensure your credit doesn’t suffer anymore.
Here are the different credit card debt relief programs and how they might impact your credit score.
1. Debt Settlement
Under this method, you choose a specific company and request them to spearhead negotiating and settling a debt with a creditor. At a fee, a debt settlement agency typically works to reduce your overall debt and may consult with your creditors for a lump-sum payment.
The debt settlement company will often ask you to discontinue payments to a creditor as they negotiate the settlement. If the agency reaches an agreement with the creditor, you will only pay the creditor a fraction of the debt, rather than the entire debt.
How Debt Settlement Affects Your Credit
A debt settlement company often asks customers to stop payments to creditors while they carry out negotiations. Payment history plays a pivotal role in credit scores. Thus, missing any debt payment might cause your credit score to drop.
That is what makes debt settlement one of the riskiest debt relief methods, in terms of hurting your credit. Most debt settlement companies do not focus on improving your credit score, but on eliminating or reducing your debt. Exercise caution when working with these companies and always select a reputable company.
Not to mention, forgiven debt comes with other tax implications – the IRS considers it as income. So, before opting for debt settlement, you may want to explore other options, including:
2. Debt Management
This approach involves using a credit counselor’s service to help in the planning and execution of a solid repayment plan. After the credit counselor assesses the situation, they will assist you in creating and following a debt management plan.
Typically, a debt management plan contains details on the amount you should pay per month and the payment duration. Your counselor may hold you accountable for following the plan.
Some debt management agencies may want to make monthly payments on your behalf. Most of these companies are nonprofits that offer their services at a low monthly fee.
How Debt Management Affects Your Credit
If you are looking for a credit relief program that will not hurt your credit, then debt management may work for you. With this technique, your credit counselor coordinates with your creditors to develop a practical repayment plan, which you should follow.
If you follow the repayment plan, then nothing will harm your credit score. In other words, you should not miss any payment.
3. Debt Consolidation
This technique involves combining several debts under a new loan. Consolidating debts allows you to streamline repayment and save money you could have paid as interest for each debt.
You can consolidate your debts in two possible ways:
- Use a new personal loan to wrap the existing debts into one
- Use a balance transfer credit card to combine all the credit card debt onto a single card
How Debt Consolidation Affects Your Credit Score
Debt consolidation is an excellent method to help you find relief from creditors without hurting your credit score. If you choose to consolidate your debt with a credit card or new loan, you might incur a hard inquiry, as new lenders may check up your credit when you’re applying for the loan.
Hard inquiries may ding your score, but the impact is often small and temporary. Besides, make efforts to make timely payments, as payment history is a critical determinant of credit scores. One missed, or late payment could dip your score. Also, avoid applying for new credit cards while paying off the current debt.
If debts is overwhelm you, then consider bankruptcy as a last resort. Declaring bankruptcy is a sophisticated legal process that requires you to go to court and hire a qualified attorney.
After filing for bankruptcy, the court will evaluate your finances and debt, and ensure you’ve exhausted all options before they grant you the bankruptcy discharge.
You might file for bankruptcy under chapter 13 or 7, and the discharge will wipe or reduce most or some of the existing debts. This outcome will prevent creditors from contacting you to pursue the amount you owe them.
How Bankruptcy Affects Your Credit
Bankruptcy can adversely affect your credit score, and it may stay on your credit history for seven to ten years. Not to mention, it will also make it difficult to obtain credit in the future.
A credit relief program may come in handy to help you minimize the pressure resulting from debt. But before choosing a debt relief plan, always consider how it can affect your credit score.