Let’s finally put this debate to rest. A lot of people have asked me how credit counseling affects your credit score. If you do an internet search on this topic, you’ll probably find an article that says something along these lines:
“When you enroll in a debt management program, your creditors will close your account. On your credit report, you will have a remark on your account that says you’re participating in a credit counseling program. This remark itself does NOT affect your credit score. However, your total credit utilization will increase, thus decreasing your score.”
This statement is 66% correct. Yes, your creditors WILL close your account and you will no longer be able to use them. Yes, you will have a remark on your account that says you’re in a credit counseling program and this will NOT affect your score.
Closed Accounts Can STILL Affect Utilization
Credit utilization is the single largest factor in your overall FICO score. It measures how much of your available credit you are using every month. Obviously the higher the ratio, there’s more risk that the lenders see.
Let’s take a look at an example:
Let’s suppose I have two credit cards: Chase & Bank of America. My total credit line on Chase is $10,000 with a balance of $5,000. My total credit line on Bank of America is $20,000 with a balance of $15,000. My total credit utilization is 66% ($20,000 divided by $30,000).
When you enter a Debt Management Program, your creditors will close your account. On your credit report, you will see it as “Account Closed by Creditor.” Just because this account is closed, doesn’t mean that the FICO scoring system is not taking into account your current utilization. Your total credit utilization will still be 66%. You can also take a look at the Credit Tip provided by my good friends at CreditNet.
So how does a DMP affect your score
It’s difficult to say how a DMP will affect your credit score. Your credit score is determined by a variety of factors. If you enroll in a DMP and you see your credit score drop, there’s not enough information to say what caused it to decrease. A lot of people actually close their accounts on their own before the creditor closes it. If you were to do this, your account will be notated as “account closed by consumer”. The reality is that it does NOT matter who closes the credit card.
The Bottom Line
If you’re trying to get rid of debt, stop looking at the past and look towards the future. Credit is only primarily used for one purpose: to borrow money. If you’re serious about getting out of debt and changing your lifestyle, start looking for ways to improve your current financial situation. If anyone has any questions, feel free to submit a question!