According to a 2018 financial literacy survey, approximately 25 percent of Americans aren’t able to pay all their bills on time, and 8 percent have debts in collection. People with financial struggles often see either a debt management plan or a debt consolidation loan as a practical solution to get their finances back on track. However, each of these solutions has a different impact on credit scores, and a debt management plan can make it more difficult to get a loan in case of a financial emergency in future. You can find a list of approved counseling agencies in each state at the U.S. Department of Justice website so you can decide the best way to pay off your debts.
How a Debt Consolidation Loan Affects Credit
A debt consolidation loan is a specific type of personal loan that simplifies the repayment of multiple debts by combining them into one affordable monthly payment. The interest rate is based on your credit score. Paying off all your debts with this kind of loan improves your credit score. It also improves your chances of having a new loan approved in future.
How a Debt Management Plan Affects Credit
A debt management plan (DMP) is an agreement between the debtor and creditor where the debtor agrees to pay, and the creditor agrees to accept monthly payments over a period of typically three-to-five years until the debt is paid off.
While debt management plans can be an effective way to pay off your debt, it can also negatively affect your credit score. When you signup for a DMP, it is reported to the credit bureau. According to Experian, a credit bureau company, future potential lenders generally have access to the information.
In the short-term, a DMP also affects your credit score since it is mandatory to close all your credit card accounts. This decreases your credit utilization, an important component in determining credit scores. Typically, people on a DMP are not allowed to borrow money until their agreement is fully paid off.
Bad Credit Loan
Having a loan approved when you have a low credit score is difficult and the options are limited. People with low credit scores are considered a lending risk, but if they can get a loan, the interest rates are higher and there may be more restrictions than regular loans.
Backed up by private banks and peer-to-peer marketplace lenders, bad credit personal loans are designed for people with poor credit and have less strict approval conditions.
Also targeting those with bad credit, the Payday loan offers small, short-term loans, usually due on the next payday. The interest and fees are typically high and not paying it back on time will result in additional finance charges.
- Depending on the debt management plan, you may have to agree to not take on any additional credit while under the debt management plan. Read the fine print in your debt agreement before you sign any new credit paperwork.