Q&A: How using a 'debt relief firm' may affect credit score

Pick your options to pay down debt wisely; each one may take a different toll on your credit

The Credit Guy columnist Todd Ossenfort
Todd Ossenfort has been chief operating officer for Pioneer Credit Counseling since 1998. He writes our weekly "The Credit Guy" column, answering reader questions about credit counseling and debt issues.

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Question

Dear Credit Guy,
If I decide to go with a debt relief company, will I still be able to buy a vehicle? And will it make my credit score drop and how long will it take to rebuild it? – Phyllis

Answer

Dear Phyllis,
When it comes to financing a vehicle, I will say that there is nearly always someone out there who will loan money for a vehicle even to consumers whose credit score is not that good.

But depending on your credit score, you may pay a stiff penalty in the form of a high interest rate. To qualify for the best rates on a car loan, you will want your credit score to be in the best possible shape. If your score is in decent shape, you may want to get your car loan before you tackle this debt.

However, if you can hold off on purchasing a new vehicle until you have your debt under control, that would probably be best. But know that it will take some time. Exactly how long is hard to estimate, and I know you may not be able to put off your car purchase for the several months, at the very least, that it will take to improve your score.

Although I have some questions about what you mean by “a debt relief company,” I can tell you that anything that affects the status of your credit cards is likely to cause your credit score to drop. Things that could affect your status would be if payments on your cards fall behind or if your cards are closed. 

Effects of debt settlement on credit score
Payment history is the most important factor in credit scoring – nothing has a bigger impact on your score than to pay your bills on time.

If by “debt relief” you are referring to debt settlement, you need to know that is going to trash your credit score.

The way a debt settlement usually works is that you will start making payments to the settlement company, who will hold those payments until they have accumulated enough to offer a settlement to the creditor.

So, even though you are making monthly payments to the debt settlement company, your creditors are not getting paid. They will very likely start calling you to find out when they will be paid.

Eventually, they will report to the credit reporting bureaus that they are not being paid (typically around 60 days late). Your accounts could go into collections, causing another negative mark on your credit report.

It is also likely your creditors will close your accounts due to nonpayment. In this case, your credit score could be hit by late payments, collections and any available credit left on the cards.

Effects of debt management plan on score
The other “debt relief” option you may be considering is a debt management plan through a nonprofit credit counseling agency. In these plans, you make monthly payments to the agency who will in turn send those payments to your creditors regularly.

This option will ensure your creditors are paid on time, every time, which will help boost your credit score. However, most creditors will also close your accounts to any additional purchases if you enroll in a debt management plan.

In either case, if your cards are at or close to their credit limit or if they are already delinquent, the effect of closing the accounts may not be that great. High credit utilization – the amount of available credit you're using – and late payments cause much more damage than the benefit you gain from the age of your accounts. Making regular monthly payments through a debt management plan for several months will likely negate any loss you received when closing the accounts.

Debt settlement advice
If you are considering debt settlement, these are my suggestions:

  • Contact a qualified nonprofit credit counseling agency and talk to a counselor about your situation first.
  • Tell the counselor you are considering a debt settlement and why.
  • Be sure to also tell the counselor that you need to buy a vehicle.
  • Your counselor will go over all of your options and this should include debt settlement.
  • Visit the Federal Trade Commission's website to find a list of qualified agencies.

I hope these tips will help you pay down your debt and be able to buy a car soon.

Take care of your credit!

See related: Debt settlement: Is it right for you?8 myths about settling credit card debt,

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Updated: 11-24-2017