Does Credit Counseling Cause Credit Problems?

By Gina Pogol
Mortgage Credit Problems Columnist

Mary Asks: Dear Gina, I am having trouble paying my bills. The interest rates on my credit cards were jacked up to over 30% and even the minimum payments are too high. I was saving money to buy a house but now I can't even pay more than the minimum on my credit cards. Could credit counseling or debt management help me buy a home?

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Gina Says:

Hi Mary,

Credit counseling or debt management can both help you and hurt you. On one hand, a reputable service may be able to lower your monthly debt payments and free up money to make a house payment or save some cash for emergencies. But on the other hand, getting into a debt management plan could cause bad credit. Lenders don't all look at debt management or counseling plans the same way. Some actually think it makes you a better prospect because your financial health is improving. Others consider it proof that you aren't managing your money well. The bottom line is--if you have bad credit, refinancing a mortgage or buying a home is harder.

How Creditors Look at Debt Management

Debt management (as opposed to debt settlement) is a plan in which your debt is restructured so that you can pay it all off in two to four years. Often, credit counselors negotiate with your creditors to get you lower interest rates and payments. Debt management can improve your credit score if it helps you to pay your bills on time.

Some creditors, like Citi, just add a note to your payment history when reporting to credit bureaus. This doesn't affect your FICO score at all. However, other card companies, like First USA, report you as delinquent until you have made three consecutive on time payments through the program. Those three months of delinquency can drop your score a hundred points!

In addition, a notation on your credit file causes FHA lenders to treat your credit history as though you filed for a Chapter 13 bankruptcy, because Chapter 13 is for all practical purposes a court-ordered debt management plan.

Alternatives to Debt Management

Some of the ads on TV urge you to sign on with a credit counseling service to get lower interest rates on your bills, even if you aren't having difficulty paying them. But there's no need to risk getting bad credit; you can just call your card companies and ask for a lower rate yourself. If you get one, that's not the same as being on a debt management plan, so you may be able to get a better interest rate without damaging your credit score.

On the other hand, if you're having serious credit problems already, consider a Chapter 13 bankruptcy filing. While creditor participation is optional in credit counseling or debt management plans, and you pretty much have to take whatever you're offered, creditors are required to participate in Chapter 13 plans. Whatever the judge or trustee says you have to pay is all you pay. And you can be free of all qualified debt in three to five years. Many reputable counselors say that if a debt management plan won't have you out of debt in less than five years, you probably need bigger guns, and bankruptcy may be the right choice for you.



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