Is Credit Counseling Bad for Your Credit Rating?
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Credit counseling services basically help you negotiate better terms on your accounts with your creditors and help you to lower your interest rate and monthly payments. Then, you send the credit counseling service one payment each month that they distribute to all of your creditors for you, so instead of writing 10 checks to pay your debts each month you only have to write one. In addition, a reputable credit counseling company will also offer you counseling on how to manage your finances, create a budget and stick with it to avoid getting trapped in debt again. While that all sounds great, there are also some downsides to going with a credit counseling service to deal with your debt.
The first thing you need to be aware of with credit counseling services is that using one may damage your credit rating. There are several reasons for this. The first is that when a credit counselor negotiates your new terms with your credits they do not negotiate how the item will be reported on your credit report. Your creditor may then report your account as delinquent, paid for less than owed, included in a credit counseling program or even as account closed by credit grantor. All of these will have a negative effect on your credit rating. If getting lower interest rates on your accounts is your only goal, it is probably a better option to negotiate your debts yourself.
The other way that credit counseling services hurt your credit score is by having all of your accounts closed. When a creditor agrees to work with a credit counselor they automatically close your account so that you can't use it anymore. A large part of your credit score is determined by how much credit you have available to you compared to how much of that credit your are using. So, for instance, if you have a credit card with a $1500 limit and you have only charge $200 on the card (about 13% usage) it will be much better for your credit score than if you had charge $1498 on the card (almost 100% usage). When your credit accounts are closed your credit limits no longer show up on your credit report as available credit. That means that even if you pay your cards completely off the credit usage factor of you credit score will never improve.
On the other hand, if you negotiate the debt yourself and make your monthly payments on time, your balances will eventually start to go down and the percent of your credit that you are using will also go down. This better credit usage ratio will help to improve your credit rating. If you do choose to negotiate your accounts and keep them open while attempting to pay them off on your own, it is vital that you do not use the cards again. Cut them up, freeze them in water...whatever it takes to stop yourself from charging on them. It would be a shame to pay on the account for months and then run the balance up again in a weekend shopping frenzy.
Another thing to consider with credit counselors is that in addition to paying your bills each month you also pay the credit counseling service a fee for handling your account. This fee varies between companies, but will be included in the payment you make to the company each month. They take out their fee before paying your creditors. If you are confident that you can stay on track and negotiate your debts yourself it makes much more sense to apply this extra money to paying your bills each month instead of paying the credit counseling service. The more money you can put to your bills monthly the fast you will be debt free.
One last consideration before signing up with a credit counseling company is that not all of the debt management and credit counselors are legitimate. Many will take your money each month, tell you they are paying your creditors, but then actually pocket all of the money for themselves. By the time you find out that your bills haven't been being paid it is often too late and they have been charged off or have seriously damaged your credit rating because they are so late. Before you sign up with any debt management or credit counseing company do your homework and make sure they are legitimate. A good rule of thumb is that if their offer sounds too good to be true it probably is.