Credit counseling is a strong approach to regaining control of your debt. This is largely because a good credit counselor will review your personal finances and recommend changes you can make to help keep your spending on the right path.
Guidance you’ll receive from a credit counselor includes establishing and living within a budget as well as saving and planning for financial challenges. Given we’re talking about managing debt, though, you might wonder if credit counseling is bad for your credit.
Let’s take a look.
What Is Credit Counseling?
As we mentioned above, credit counseling is more like financial coaching than anything else. While commercial credit counseling agencies do exist, many people avail themselves of assistance from non-profit credit counselors. Most experts recommend going this route as it removes the incentive for counselors to advise you into strategies from which they could derive income personally.
This comes into play because in addition to the advice and support you’ll get from a credit counselor, they’ll also review your finances to determine your best path forward for clearing your debts. Sometimes it’s simply a matter of re-prioritizing your budget to tackle your debt more effectively. However, in some situations, a credit counselor might advise you to take a consolidation loan, enter a debt management program, sign up for a debt settlement program or file for bankruptcy protection.
While each of these actions does entail an effect on your credit score, some are worse than others.
Methods include personal loans, credit card balance transfers and home equity lines of credit. As you might have guessed, each of these requires your credit rating to be in good standing as you’re essentially taking another loan to satisfy your outstanding accounts. The advantages (when done right) are lower interest rates and combining multiple accounts under one umbrella so you’ll only make one (generally lower overall) payment each month.
Debt Management Program (DMP)
Under this approach, a credit counselor will negotiate with your creditors to garner fee and interest rate reductions to make your debt easier to pay off. If the holders of your debt agree, you’ll have to close certain accounts and make your payments through the credit counselor, who takes over responsibility for ensuring your bills are paid on time. Closing accounts will have a negative effect on your credit score in that they will shorten your credit history and could raise your credit utilization ratio.
A debt settlement agent will negotiate on your behalf for forgiveness of a portion of the principal balance you owe. Debt settlement programs often encourage you to stop making payments to your creditors altogether and deposit the money into an account the settlement program will use to pay off your accounts as settlement agreements are reached. The holders of your debt will tell credit-reporting agencies you’ve stopped paying, which will impact your credit score negatively.
Considered a last resort by many in the debt industry, bankruptcy gives you the ability to walk away from most forms of debt without repaying it — or paying as little as possible to clear it. Some forms of bankruptcy require you to sell off personal assets to amass funds to satisfy as many of your creditors as possible. As you might expect, bankruptcy protection has the most significant impact upon your credit score of all the methods listed here. A bankruptcy can be reflected on your credit report for as many as 10 years.
Which brings us back to our original question.
Is Credit Counseling Bad for Your Credit?
Counseling in and of itself is not. In fact, depending upon the nature of your problem, if you follow the advice of the best credit counseling company you could actually improve your credit score. However, the overall impact of working with a counselor depends upon the severity of your circumstances and what the best strategy for dealing with it turns out to be.
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