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If you find yourself heavily in debt, you might turn to a debt management plan (DMP). These programs can help you get out of debt, but they can also have a negative impact on your credit.
If you’re in a DMP and paying down your existing debt, you might find yourself looking to apply for a new loan, such as a mortgage or auto loan. While being in a DMP may make it harder to get these loans, it will not automatically disqualify you.
What is a debt management plan?
To enter a debt management plan, you have to work with a credit counseling organization that specializes in helping people with debt. The credit counselor negotiates with your creditors on your behalf to set up a payment plan. Typically, you’ll adjust the terms of your loans by extending the amount of time you have to pay them back or getting their interest rates and fees adjusted.
Debt management plans can take years to complete. During that time you’ll have to be careful about making your payments every month and may not be able to use your credit cards and other sources of credit.
How does a debt management plan affect your credit?
When you set up a debt management plan, you often adjust the terms of your loans, changing their interest rates or how long it will take to pay them back. DMPs also frequently involve restricting your future use of credit cards.
Many creditors will report details of your debt management plan to the credit bureaus. For example, if you settle for less than you owe, they may report the balance you’re not paying to the credit bureaus. Even just lowering the rate of a loan may require that a lender report a portion of the debt as charged-off. This has a negative impact on your credit score.
Over time, your credit score can improve as you go through the debt management plan and rebuild your payment history, but the short-term impact is likely to be a large drop in your credit rating.
It’s important to note that there’s a big benefit to being proactive with your debt. If you realize you’re in over your head and set up a DMP before you start missing payments, you might be able to dodge much of the negative impact on your credit.
Will a debt management plan affect your ability to get loans?
Yes, a debt management plan can impact your ability to get new loans. This is especially true if some of your lenders charge off a portion of your debt and report that information to the credit bureaus. Some lenders will also add a note to your credit report that you’re in a DMP, though this note won’t have a direct effect on your credit score.
When a lender looks at your credit report, it will first see your credit score, then examine the details of your credit accounts. If you have poor credit and only entered a DMP recently, many lenders will hesitate to give you a loan.
However, some lenders see the fact that you’re working to pay your debts as a good sign, especially if you’ve been following the terms of your debt management plan for a while. You might need to shop around to find a willing lender, but you should be able to find one who is willing to take a chance on giving you a loan.
What are alternatives to a debt management plan?
If you’re considering a debt management plan, there may be other routes you can take.
Talk to your creditors
If you’re struggling with debt, you aren’t obligated to speak to your lenders through a debt management company. You can reach out to your lenders directly to discuss your situation.
Simply reaching out and explaining your situation may be enough to convince a lender to waive a fee or accept a late payment.
Consolidating your debts means taking on a new loan to replace your existing one, turning multiple debts into a single one that is hopefully easier to manage.
This can lower your monthly payment and even lower the interest rate of your debt, saving you money in the long run.
If you’re in significant debt, you might be able to convince your lenders to settle your debt for less than the full amount that you owe. For example, if you owe $5,000, you could offer to settle your loan for $3,000 and have the lender charge the rest off.
Some companies specialize in negotiating these deals on borrowers’ behalf, but these services cost money. The drawback of this plan is that it can have a significant negative impact on your credit, although it may help you recover in the long term.
If your situation is truly dire, you can declare bankruptcy.
This is a legal process that lets you restructure your debt or eliminate it entirely. However, it can take time to go through the process and it will cause a massive drop in your credit score that can last for up to a decade.
Debt management plans are one tool that borrowers can use to get out of debt. However, you should be ready to follow through on the plan and commit to the years it will take to get out of debt. While you may have to put getting new loans on hold while you get started with your debt management plan, over time the DMP should help you improve your credit and start qualifying for better loans.