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Can credit repair companies ruin your credit score?

How $23,000 in credit card debt cannot be magically erased

By

To Her Credit
To Her Credit, Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for CreditCards.com, and also wrote for MSN Money, Interest.com and Bankrate.com, and has guested on Martha Stewart Radio and other programs. See her website SallyHerigstad.com for more personal finance tips and free budgeting worksheets.
Ask Sally a question, or read her previous answers in the To Her Credit archive
Question for the CreditCards.com expert

Dear To Her Credit,
My husband and I have an insanely high total credit card debt of $23,000, spread across 10 cards. We no longer use them, and we are working on paying them off. My question: Isn't it true that the companies who consolidate and reduce credit card balances damage credit ratings, much like bankruptcy? I see them advertised and they make it look so easy, but I can't believe that settling a debt for less than the balance won't hurt one's credit score.   -- Jo Anne

Answer for the CreditCards.com expert

Dear Jo Anne,
Your instincts are right -- it's not as easy and consequence free as the ads make it sound.

Not all companies do the same thing, however. Simply consolidating your debts -- taking one loan to pay off your other debts -- may actually help your score. After all, your creditors get paid in full, plus you should have a better chance of keeping up with the payments when they are lower. You can do this kind of "consolidation" yourself by finding a better loan, a personal loan, or even a home equity loan, and paying off high interest loans.

When a company promises to cut your debt in half or some such thing, however, that's another story. According to Erica Sandberg, president of Sandberg Financial Education Services, doing so will definitely affect your ability to get credit. "It doesn't impact the score. It has an impact on how other lenders see you."

I don't recommend that you use a debt reduction company for several reasons:

  • Not all debt reduction companies are the most well-respected businesses. In fact, for-profit debt reduction companies are illegal in some states.
  • They can't do anything for you that you can't do yourself. And they charge plenty. That's money better spent paying off debts. (That low fee they advertise is just the beginning!)
  • Debt reduction companies only make sense when people are far, far behind in their payments and will probably go bankrupt without it. In your case, you're better off just paying the debts.
  • Your creditors may still sue you or take other measures to collect if they find out you are dealing with a debt reduction company.
  • The company cannot guarantee that it can lower your balance, or how much they will be able to.
  • If the company succeeds in getting your balance lowered, you'll owe income tax on the amount of the reduction. The IRS sees forgiveness of a debt the same as income, so just when you think you've gotten out of debt, you could get a big tax bill.
  • Yes, using a debt reduction company will affect how creditors see you, which may cause you to pay higher interest rates or even have trouble getting credit in the future. That could cancel out any money you save now.
  • Finally, using a debt reduction company to get out of debts doesn't solve anything long term. Like bankruptcy, debt reduction leaves you with the same circumstances that got you in trouble in the first place. If your expenses exceeded your income, they still do. If one or both of you can't hang on to money, that's still true.

More important than your credit score is the fact that you have a high burden of debt. It's not the worst debt I've seen; In fact, it's only about twice the national average for a family. Still, it's causing you stress -- and costing you a lot of interest! "She's focusing on one thing, her credit score," Sandberg says. "You're paying all this debt and you're worried about your score? Get your debt down!"

It's time to make a plan to take charge of your financial life. You don't need a debt reduction company to fix things. You can keep working on paying those debts off while you make plans for the future. Take care of your bigger financial picture, and your credit score will be fine.

See related: The good guys of credit repair 

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Published: September 5, 2008


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