The Credit Risks of Entering a Debt Management Plan

If you struggle with debts you can't manage on your own, credit counseling is an option. Credit counseling organizations may use debt management plans to help you get back on your feet financially. Through a debt management plan, your credit counselor works with your creditors to lower balances, eliminate fees or reduce interest rates. Each month, you must pay a preset amount to the credit counseling agency, which then distributes payments to your creditors. In certain cases, however, debt management plans can prove detrimental to your credit rating.

Debt Settlement

A reputable credit-counseling agency's goal is to help you get out of debt --- not to preserve your credit rating. By negotiating settlements with your creditors, credit counselors can eliminate a portion of your debt and make your financial burden easier to bear. Settling a debt for less than you owe, however, has a considerable negative effect on your credit scores, as it indicates that you didn't satisfy your original contractual obligation to pay off the debt in full.

Credit Reporting

If your creditors agree to the debt management plan your credit counselor proposes, they may update your credit report to reflect the fact that you're currently enrolled in credit counseling. While this doesn't directly affect your credit score, lenders who pull your credit report see that you participated in a debt management plan. Although all lenders view credit counseling differently, some may view your past debt problems as a risk factor of future default.

Missed Payments

Reputable credit-counseling agencies work to get the best deal possible for you, but this sometimes involves destroying your credit in the process. Credit counselors know that your creditors are more likely to agree to reduced payments and lower balances if your account isn't current. Thus, debt management plans may involve withholding your monthly payments from your creditors until your account falls into delinquency and the creditor is more willing to negotiate.

At 35 percent of your credit score, your payment history is the single greatest factor contributing to your credit rating. The more payments a credit counseling agency withholds from creditors, the lower your credit rating plummets.

Scams

Not all credit counseling agencies are legitimate. Certain companies charge such high fees that consumers can't keep up with reasonable payments to their creditors. Still others set consumers up with debt management plans, only to vanish several months later with their clients' money without ever negotiating with their customers' creditors.

Falling victim to a scam places your credit at risk because you're robbed of funds that could have been applied to your outstanding debts. Not only do the missed payments damage your credit rating, but you're left unable to catch up on your obligations to your creditors due to your financial loss. The National Foundation for Credit Counseling maintains a list of reputable, licensed credit-counseling organizations around the country to help consumers avoid scams.