Article Updated August 2, 2018.
Many people ask, what’s the best way to get out of debt? Then they may often think, but I have good credit, and I really don’t want to hurt it. There are many ways to lighten your debt load, and not all of them will have a major negative effect on your credit. But it’s also important to consider your situation and needs when weighing your options.
To help you decide which debt relief plan is best for you, we’ve provided a brief overview of each option and how they may affect your credit in the short term and long term.
A Few Things to Remember
Before we dive into the different debt relief options, understand that the debt you carry makes up just under one-third of your credit score. So, when you pay off debt, especially credit cards that are close to their credit limits, you should see improvement in that part of your score.
However, understand that our analysis of credit relief plans is based on generalities. It doesn’t necessarily represent exactly what will happen in your case.
How far your score drops—and how quickly it bounces back—depends on a lot of different factors. If your payment history always shows on-time payments, for example, and you suddenly file for bankruptcy, your score will probably drop more than someone who was already severely delinquent.
But it’s impossible to predict how a particular approach will impact your individual credit if you’re not familiar with your credit history—so get a free Credit Report Card from Credit.com to see a summary of that history. Remember too, that you can obtain your free annual credit reports once a year from annualcreditreport.com.
With this information in mind, here are the main approaches to debt relief you may consider, along with a review of the impact they could have on your credit reports and scores.
| Debt Relief Option | Immediate Credit Impact | Long-term Credit Impact |
| Debt Snowballs and Avalanches | None | Reliably positive |
| Debt Consolidation | Small impact (positive or negative) | Minimal |
| Credit Counseling | None | None |
| Debt Management Plan (DMP) | Moderate impact (positive or negative) | Minimal |
| Debt Negotiation or Settlement | Severe damage | Slow recovery |
| Bankruptcy | Severe damage | Slow recovery |
Debt Snowballs and Avalanches
If you prefer to pay off your debt on your own, you might consider a snowball or avalanche payment method. The debt snowball is when you pay off your debts one at a time, starting with the lowest balance. The debt avalanche works similarly, except you start with your highest balance and work your way down.
It doesn’t make much of a difference whether you choose the avalanche method or the snowball method, but many find the snowball method is easier to stick to. Neither approach will hurt your credit, as long as you make the minimum payments on all of your cards on time.
Immediate Credit Impact: None
Long-Term Credit Impact: Reliably Positive
Debt Consolidation
Combining multiple card debts into a fixed-rate consolidation loan can be helpful, but it isn’t a strategy for getting out of debt in and of itself. After all, you still have to pay back the loan. A consolidation loan is more like a tool to get out of debt faster.
Because consolidation loans often offer lower interest rates than the credit cards themselves, you can pay off your debt faster. And if you have a lower monthly payment than before, you can better avoid late payments. This will help your credit score recover more quickly if you’ve fallen behind in the past.
But consolidating credit cards with a loan may have a positive or negative effect on your scores. It’s one of those “it depends” situations.
On the plus side, if you pay off a card balance that’s close to the credit limit, you may improve your “utilization ratio”—the ratio that compares your credit limits with the balances you currently have—provided you leave the card open after paying it off. But simply moving balances from one card to another is unlikely to do a whole lot for your scores.
On the other hand, you’ll have a new loan on your credit reports, and most credit scoring models will count that as a risk factor, which could mean a dip or drop in your scores.
The exception? If you take out a loan from your retirement account to consolidate credit card debt, you’re more likely to see your credit improve. Retirement account loans aren’t reported to credit reporting agencies, so your credit reports will show less debt with no new loan. However, retirement loans carry their own risks, so proceed with caution.
Immediate Credit Impact: None
Long-Term Credit Impact: Minimal
Credit Counseling
A credit counselor is a professional who can advise you on how to handle and successfully pay off your debt. A simple call to a credit counseling agency for a consultation won’t impact your credit in the slightest. But if the credit counselor or agency enrolls you in any kind of consolidation, repayment, or management plan, that could affect your credit.
Make sure you fully understand the potential impact of any debt relief program before you sign up. Don’t be afraid to ask the credit counselor how a new plan could alter your credit.
Immediate Credit Impact: None
Long-Term Credit Impact: None
Debt Management Plan (DMP)
With a Debt Management Plan (DMP), you make one monthly payment to a counseling agency, which then disburses payments to your creditors. This kind of plan can affect your credit in several ways.
Some creditors may report that a credit counseling agency is repaying the account. Don’t worry if they do. FICO, the data analytics corporation that calculates consumer credit risk, ignore such reports. An individual lender may care, but FICO doesn’t. Of course, any late payments or high balances on accounts will continue to impact your credit score.
With the help of the counseling agency, you can stay current on your payments, and that can improve your credit score. “Most major creditors will re-age your accounts after you’ve made three on-time payments in the required amount,” says Thomas J. Fox, community outreach director for Cambridge Credit Counseling.
Re-aging an account can be caused by making a payment on the account. Even if you bring it back to “current” status, the late payment(s) can still report for seven years. Since recent late payments can really hurt your scores, getting up to date on your payments now is a smart move, especially as the sting of past late payments fades over time.
However, you’ll have to close your credit cards when you agree to a DMP, and that will likely lower your scores. How much it will hurt depends on everything else in your credit reports, including whether you have other credit accounts, such as car loans or mortgages, that you pay on time.
The impact may take time, says Barry Paperno, community director for Credit.com. He states it’s because “balances and limits won’t necessarily change right away, and utilization will be the same as before closing accounts.
He goes on to explain, “Closing an account in and of itself isn’t considered negative by the score. Over time, however, having closed the cards can hurt the score, as closed cards with zero balances are excluded from utilization and ultimately fall off the credit report much sooner than open cards that have been paid off.”
“Plan on getting a secured card when you complete the DMP so that as long as you keep a low utilization percentage on that one card, you can achieve a good score—with any [late payments] fading well into the past,” Paperno continues.
“Also, your old closed cards will continue to contribute positively to your overall length of credit history for as long as they remain on your credit report (typically 7 or 10 years).”
Immediate Credit Impact: Moderate impact (positive or negative)
Long-Term Credit Impact: Minimal
Debt Negotiation or Settlement
Some creditors may allow you to settle your debt, which permits you to pay less than the full balance you owe. But creditors typically won’t settle debts with consumers who make their payments on time, so it’s a better option for those that already have several late payments on their credit report.
On top of that, “most creditors will report the settlement as something like ‘paid less than full balance’ if you settle the debt before it has been charged off,” warns Michael Bovee, community manager for DebtConsolidationCare.com.
A creditor will generally charge off debts when borrowers fall 180 days behind. And charged off debts often get turned over to collection agencies.
Bovee further explains, “When you settle a charged-off debt, getting it reported [with a] zero balance due will not in and of itself help your credit because the damage has already been done.” But it could help you ward off further damage from, say, a potential lawsuit.
In other words, settling an account before it gets charged off can prevent it from going to collections and adding another negative item to your credit reports—or causing other harm.
Brad Stroh, co-CEO of Freedom Debt Relief, adds, “Debt settlement hurts people’s credit scores but helps their credit profiles. [It’s] worth considering for anyone struggling to pay a lot of credit card debt, despite its negative effects on credit scores.
It is far easier to rebuild one’s credit than to get out of debt, and people carrying a lot of debt likely have credit problems already.”
Immediate Credit Impact: Severe damage
Long-Term Credit Impact: Slow recovery
Bankruptcy
It’s well known that filing for bankruptcy will hurt your credit score—bankruptcies can stay on your report for up to 10 years from the filing date. However, with updates on the credit scoring algorithms, bankruptcy isn’t the credit death knell it used to be.
Credit scoring algorithms typically segment consumers into subgroups called “scorecards.” If you experience a significant negative credit event, such as a bankruptcy, you’ll likely be compared with other consumers who’ve experienced something similar for credit scoring purposes.
That may bring a little bit of comfort, but it also means you might have a good shot at improving your credit scores if you make a real effort to rebuild your credit after your bankruptcy is discharged.
As far as your credit is concerned, you can recover from Chapter 13 bankruptcies more easily than other types of bankruptcies. In Chapter 13 bankruptcies, you typically pay back some or all of your debts over a period of three to five years, and they come off your credit reports seven years after the filing date.
If it takes you four years to complete your Chapter 13 plan, you have to wait only three more years before the bankruptcy disappears from your reports.
However, you’ll probably end up paying more in a Chapter 13 bankruptcy than a Chapter 7 bankruptcy, where you wipe out all or most of your debts by selling some of your assets. Make sure you discuss both options with a qualified consumer bankruptcy attorney.
Immediate Credit Impact: Severe damage
Long-Term Credit Impact: Slow recovery
Coping with Debt
If you find that you are one of many people that finds it difficult to pay your bills and you are finding yourself buried with notices from creditors, then you may benefit from some kind of debt relief program whether it is bankruptcy, a debt consolidation program, or a debt consolidation loan.
Debt relief services, as mentioned above, can help you find viable ways to dig yourself out of debt and help you gain the financial freedom and stability you crave. Debt counseling may also be something you should consider to ensure that you remain debt free in the future.
It is good to remember that debt settlement or total debt relief may also come with its own set of risks:
- Sometimes you are required to deposit money into a special savings account where it will be held for thirty-six months or longer before all the debts are settled. This is why it is so important to understand your budget and how much you can realistically afford to put toward your outstanding debts each month
- The creditors are not obligated to negotiate or come up with a settlement with you at all. Therefore, you must remember that there is still a possibility that you will have to find other ways of debt relief that do not involve settlements or negotiating debts for smaller amounts
- You may experience a brief hardship when it comes to your credit scores and history. Sometimes a debt relief or debt settlement company will require that you stop making payments directly to the creditor and this may come with negative marks on your credit file.
- It is also important to be aware of any debt settlement and debt relief and elimination scams that may be going around. Always research the companies or the debt relief programs you are interested in and make sure they are offering legitimate and reliable services. Also, make sure that the debt consolidation program you work with informs you of all the risks that may be associated with the particular programs they are offering.
Getting Back on Track
Whichever method you choose, keep in mind that the ultimate goal is to pay off your debt, so you can save and invest for future goals. A hit to your credit may be worth it if it means you can finally get your balances to zero.
Monitor your credit, consider getting a secured card if necessary, and keep your financial situation in perspective.
“People just worry about their credit too much,” says Fox. “If your couch is on fire, would you not throw water on the fire because you don’t want to damage the upholstery?”
As you work to pay off your debts, it’s a good idea to keep an eye on your credit score to see how you’re improving. Get your credit score for free from Credit.com.
You can also carry on the conversation on our social media platforms. Like and follow us on Facebook and leave us a tweet on Twitter.
Image: Alija
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