Debt Relief and Your Credit Score

If you are looking into debt relief programs and landed on this page, chances are you’re reading because you want to know the impact to your credit report and credit score if you use credit counseling, debt settlement, or bankruptcy as a way to resolve debt. You may have already realized that needing one of these three debt intervention tools means you are in the least likely position to spend, or to be seeking out new credit products in the near future.

Credit-Shmedit! I have to get a handle on my debt before I can afford to take on any new credit and more payments!

The three most legitimate debt relief intervention options do indeed affect your credit report and/or credit score. Each method hurts your ability to get new loans, or certain types of loans, and for close to the same amount of time. So stop thinking about your credit score, and start thinking about getting out of debt in the quickest and most affordable way.

If you are concerned about how each different type of debt relief program will work for you now, and still allow you to accomplish credit goals in the near future, you will be well prepared after reading this page.

I am going to lay out the credit report, credit score, and access to new credit product impacts from debt relief programs in the order that most of the public perceives as the least confrontational, and end with the “B” word. Each comparison is generalized, but in a way that will help you understand your credit needs for the next 3 years, set beside the debt relief programs you are on this site to learn more about. The comment section at the bottom of this page is a great place to post your questions and concerns and get feedback in order to take the information and apply it to your specific situation right now, but with an eye on your credit future.

Credit Counseling Affects Your Credit Report, but Not Your Score

Once you enroll in a debt management plan through a nonprofit credit counseling agency, your previously active credit cards will be updated to show your account was closed by credit grantor (unless they were already closed, or you get proactive and close them yourself prior to consolidating with a credit counseling agency). Recently closed accounts can have a slight impact on your credit score, but typically only a few points.

While enrolled in a credit counseling program there are often limits to the types of financing you can get in the first 12 months. This is because many creditors will inform the credit reporting agencies that your account with them is part of a consolidated repayment plan. Because credit counseling agencies will normally want to have all or most of your credit card debts enrolled in the plan, this type of reporting could appear several times across your credit report.

Debt management programs with credit counseling companies run on average 4 to 5 years. 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) shortly after enrolling and 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 credit card debt. But you will have also eliminated year’s worth of open revolving unsecured credit history. Credit “recentness” is one of the better attributes of open and active revolving consumer credit cards being on your credit report. This is one of the simpler aspects of your credit report and credit scoring factors to rebuild. Losing the long credit history when accounts are closed can be rebuilt over time too.

More detailed information about how debt management plans work to help you manage your credit card debt can be found in my credit counseling article series. You can also call and speak with a certified counselor and learn more about how debt consolidation works by calling 888-317-8770. You can often get an exact monthly payment quote in that single call too.

I typically suggest taking any quote for debt relief and sleeping on it for a few days at a minimum.

Settling Debt Can Hurt and Help Your Credit

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. But if you are reading this and are already 60 or more days late, your credit is already hurt. If you cannot afford a debt consolidation plan with a credit counseling service, you may now realize that your options for debt relief could be limited to settling debt. In fact, settling debt could help your credit faster than any other option when you are already significantly behind.

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. Just know that this is going to cause your credit score to fall significantly until your settlements are complete.

How debt settlement impacts your credit report and credit score will vary widely from one person’s situation to the next. I have seen credit bounce back quickly with many files that are similar to this college professor I worked with who shared her story with the Detroit Free Press.

Since another major portion of your credit score is factored on repayment history, your credit report and score is going to take a beating. 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.

5 Ways Your Credit Bounces Back Quicker From Settling

• How long it takes to settle your debts. Settling a credit card debt directly with your bank before the account goes 180 days without payment can be ideal with many banks (there are some exceptions).
• Did your account get sold to a debt buyer 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 went late before they 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 (contrary to what you may here), or plan your settlement strategy out in a manner that will improve your access to new credit products sooner.

In general, when taking into consideration more than two decades of hands on experiences of working with people to resolve debts by settling balances for less, I see people’s credit score, and access to new credit products, recover in 12 to 18 months. This would be a year and a half after the last account gets settled, and the credit reports are updated to reflect 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 have gotten approved using FHA underwriting on a home loan within a few months of finishing their settlement plan. Many of us are also able to get funding for student loans, and qualify for new auto financing, after completing settlements. Those who fit many of the 5 bullet items above can reach some credit goals much earlier than would have been the case had they filed chapter 7 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.

How Chapter 7 Bankruptcy Affects Your Credit

Chapter 7 bankruptcy stays on the public record section of your credit report for 10 years. That is the longest shelf life of all debt relief options! But the long negative credit reporting and the initial Olympic ski slope credit score drop is misleading. The perception of chapter 7 bankruptcy is that your credit report and credit score is being sentenced to prison for 10 years. Not true!

There are a host of reasons to look at all of your options to stay out of bankruptcy. But your ability to access new credit soon after your debts are discharged in a chapter 7 is not as legitimate a concern as many would have you believe. If you are struggling under a heavy debt load, and can qualify for chapter 7, it should be viewed as an option of first resort, not the one that should be avoided at all cost. In fact, chapter 7 bankruptcy viewed from a pure cost basis, will beat the cost of debt settlement, and credit counseling, for the vast majority of people.

People discharging debts through chapter 7 bankruptcy find credit card offers in their mail within weeks or months after the bankruptcy is finalized (chapter 7 typically only takes 90 days from start to finish). The credit card offers do not come with high limits, and are going to have higher interest rates, but they are often there quickly.

Chances are you would not see offers for new credit if you continued struggling your way through your debts, because you are carrying too much of it. Chapter 7 bankruptcy would wipe out your unsecured credit card bills and other debts. For many this will mean a healthier debt to income ratio than you have had for years! There is also the fact that creditors know you cannot file chapter 7 bankruptcy again for 8 years, and consider that an acceptable risk.

Taking on new credit card debts after filing for bankruptcy relief in today’s economy, and with the lower credit limits that will be available, will make it harder to get in debt over your capacity to pay it back.

What are some common credit and loan standards after filing Chapter 7 bankruptcy?

• FHA (Federal Housing Authority) underwriting for new home loans will put qualifying for a new mortgage or home purchase out of reach for a minimum of two years (some exceptions). This means you rent, or stay put for a short time. This certainly blows the 10 year credit report and credit score concern out of the water!
• Underwriting for student loans you want to cosign for will be out of reach for a few years – not 10.
• You may be able to get decent auto financing within 12 months after filing for chapter 7 bankruptcy. See how that’s measured in months, and not years?

Filing chapter 7 bankruptcy, and getting a fresh start with your personal finances, is not the end of the road it is made out to be. It can actually be a necessary beginning to a new credit life. You simply need to know how lenders and underwriters view the bankruptcy, and be proactive and smart with rebuilding credit. The 10 year credit report stain is more like a coffee cup smudge within two to three years.

How Chapter 13 Bankruptcy Affects Your Credit is Another Thing Entirely

Chapter 13 is the worst of all debt relief solutions when it comes to credit impacts. The court trustee is going to be overseeing virtually every aspect of your financial life during your repayment plan. Chapter 13 bankruptcy plans go for either 3 or 5 years. The majority are 5 year plans.

Chapter 13 stays on your credit report for 7 years.

The bankruptcy trustee will have to approve and monitor your household budget and expenses for the life of the chapter 13 repayment plan. If you wanted to take on any new credit, no matter what it is for (virtually), you have to get the trustees permission, and that is not very common.

If there is any debt relief solution that is like a jail sentence to your credit, this would be it. There is really no flexibility to a chapter 13 bankruptcy. Historically about 70% of chapter 13 filers cannot, or choose not, to stick it out and complete the repayment.

There are very real benefits to a chapter 13 bankruptcy. You do get the courts protection from creditors who could otherwise use aggressive collection strategies, like suing to collect. You get to keep personal items that may have not been permitted in a chapter 7. Your retirement accounts are nearly always protected. Chapter 13 can even make your home more affordable by helping to cram down a second mortgage if you are underwater on your loan.

If you cannot muster up the cash to settle with creditors, or hold too much equity in your home, or have other assets to protect, chapter 13 will make sense. Just not from a future credit planning perspective.

Your Credit Reports and Scores are a Utility for Consumption

Credit reports and credit scores have a utility function for both you and lenders. Banks use your credit rating to price risk. You use your credit score to get better interest rates when accessing credit for consumption. If you have a good score and healthy looking credit report, and are in the market for a loan, you are using your credit history and credit rating utility function. The better your credit rating, the lower the costs you will pay for making purchases using credit. Long term this will mean a savings of tens, if not hundreds of thousands of dollars.

Just think about what a percentage point or two on an interest rate tied to a 30 year fixed mortgage can mean to you in savings over the life of the loan!

What if you are not in the market for new loans, or maybe would like to be, but have more debt than you can manage?

Another example of the new normal are the increasing changes to credit underwriting standards for home loans that will impact most people. The CFPB’s new qualified mortgage rules can impact your ability to get approved for a new home loan, or refinance an existing loan. I expect there to be student loan underwriting changes in the coming years as well. What does this mean to you?

Your credit report may not have a single blemish. Your credit score may be over 700. But if you are carrying too high a percentage of monthly debt payments compared to your monthly income, your credit rating has lost some of its utility function. You cannot effectively use that excellent rating without first implementing a strategy to pay off debts and bring your DTI in line with the lending standards being used in the credit market you are interested in.

If you are on this web site and reading about debt relief programs, it likely means you are in an emergency situation with your debt, or you recognize you soon will be. The three options for debt resolution outlined above may be what you have to consider in order to put yourself back on track financially.

Putting aside the hyper messaging in society about the importance of your credit rating; What do you need your credit rating for right now, or over the course of the next 24 months?

If you have a debt problem, your credit rating has lost some or all of its utility function already. The utility function can be returned once the debts you are dealing with have been resolved, or paid down to a point where you’re credit utility returns.

Conclusion:

Credit counseling services, debt settlement programs, and bankruptcy are the 3 main debt intervention options. Each one of them affects your credit score and credit report in different ways. Even slugging it out month to month to pay your bills on time – where your too high debt to income is going to prevent access to new credit – amounts to much the same as the debt relief solutions outlined above.

What may surprise you is that all of these methods for resolving debt track fairly closely with the other when it comes to being able to access some new credit products.

Hopefully you are now better prepared to understand that when you are struggling with debts you can no longer afford, but are more concerned with your credit score, your attention is on the wrong thing. Focus on solving your personal debt and budget crisis first. Credit will be available again, and much quicker than you may have thought.

Do not let others sell you on the importance of maintaining credit when you cannot maintain payments on the debt you have. Especially when your debt to income means you are not going to be getting approved for credit – even with a high credit score.

Focus on the debt relief solution that is in line with your current financial ability, but with an eye on your future credit goals and needs in the next two to three years. A good process of elimination is to see if you can pay your debts back using a credit counseling agency and the debt management plan approach. Talking with a credit counselor in order to get an exact quote of how low they can get your monthly credit card payments is free. You can also click on the settlement estimate request below, fill that out, and get an email with an estimate of what settlement will look like for you.

If a credit counseling service cannot get your payments to a place where they are affordable, and contrary to the desire most of us have to avoid bankruptcy, I would next suggest speaking to a bankruptcy attorney about chapter 7 debt discharge. If you cannot qualify for chapter 7 bankruptcy, or learn something about it that would cause you to cross it off the short list of workable debt relief options, then get started understanding how debt settlement could work for you. We can help you with that.

If you have any questions about your specific debt issues, and how solving a debt problem affects your credit report, credit score, or near term credit goals, post in the comments below for feedback.