Debt Consolidation vs. Debt Settlement vs. Debt Management Plan: Credit Impact

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The following is presented for informational purposes only.


  • A debt consolidation loan may be able to help you quickly improve your credit score, but only if you pay down your debts and improve your credit utilization ratio.
  • Debt settlement is almost always harmful to your credit, but is better in the long run than not repaying your debts at all.
  • Debt management plans typically require you to close your creditor accounts, which can create a short-term credit score reduction. Long-term, however, most scores improve greatly as a result of completing the plan.

If you’re looking for a way to get debt free, you may be considering consolidating your debts, trying to settle with your creditors, or getting on a debt management plan. It can be important to understand and compare your options, because they could affect your finances and credit in different ways.

Debt consolidation credit impact

There are many ways to consolidate your debts, but generally they all involve taking out a new credit account and paying off your existing balances. Doing so can simplify your finances as you’ll have fewer monthly bills to manage. You may also be able to save money if your new account has a lower interest rate than the debts you’re consolidating.

If you own a home, you may be able to take out a home equity loan or use a cash-out refinance to consolidate your debts. Taking out a personal loan could also be an option. Although personal loans may have a higher interest rate than home loans, you take on less risk since you don’t need to put up collateral. You also might be able to transfer debts to a credit card that has a zero percent promotional annual percentage rate (APR) on balance transfers, which could save you a lot of money as you pay down the balance.

Tommy Lee, a principal scientist at FICO®, says, “Consolidating debts may or may not help one’s FICO® Score, depending on how the debt is consolidated and what actions are taken afterward.” Lee points to the “amounts owed” credit-scoring factor, which makes up about 30 percent of your FICO® credit score. “Key measures in the ‘amounts owed’ category include utilization ratios, as well as the total dollar amount of debt owed,” says Lee.

Your utilization ratios are the percentage of available credit on revolving credit accounts (e.g. credit cards or lines of credit) that you’re currently using. Your ratios on individual accounts can impact your scores, but your overall utilization ratio may be more important to your scores. In either case, having a lower utilization rate is better.

If you take out an installment loan, such as a personal loan, and pay off revolving debts, you can quickly decrease your utilization ratios which could help your scores. Opening a new credit card and transferring the balances could also help because you’re increasing your available credit by opening the card. However, you’re not decreasing your overall utilization as much because the new credit card is still considering in the utilization calculations.

No matter which consolidation option you use, you’ll want to try and avoid falling deeper into debt after consolidating. Paying off your credit cards with a personal loan could backfire if you end up maxing out your newly available credit limits. If you think this could happen, you may want to close your cards after consolidating. It may not be ideal for your credit scores, as your utilization rate could increase, but it might be the right move for your finances.

Debt settlement credit impact

When you settle debts, you’re offering to pay your creditors less than the full amount you owe. It may sound like a good option, but you have to be careful because trying to settle your debts can hurt your credit and may actually wind up costing you more overall.

Creditors generally won’t agree to a debt settlement agreement unless you’ve shown you’re unable or unwilling to pay the full balance. Knowing this, debt settlement companies may suggest you stop making payments altogether.

However, Lee says, “Payment history is the most important category in a FICO® Score, consisting of about 35 percent of the FICO® Score calculation.” Late payments can hurt your scores, and the impact can increase the further behind you fall on your payments.

There’s no guarantee that the creditor will agree to settle your accounts. The creditors may charge you late payment fees, and your account may continue to accrue interest while you’re not making payments. But in the end, the creditor may decide to sue you for the debt rather than settle.

Also, a settled account indicates you didn’t fully repay your loan. “Therefore, settling a debt for less than the full amount owed could hurt one’s FICO® Score,” says Lee. He says the impact may be less harmful than paying nothing and having the account sent to collections or defaulting, but it could still lower your scores.

Debt management plan credit impact

Credit counseling organizations may offer a debt management plan (DMP) as a path to paying off your unsecured debts, such as credit cards or personal loans.

When you sign up for a DMP, the organization will act as a middle-man and negotiate on your behalf. It may be able to get your creditors to decrease the interest rates on your accounts, waive fees, or lower your monthly payment amount. A DMP can also simplify your bills because you’ll make one monthly payment to the organization, which will then pay your creditors on your behalf.

“The FICO® Score ignores any mention of credit counseling or debt management plans on your credit report,” says Lee. “It also won’t hurt your FICO® Score if your credit report includes one or more accounts described as being paid through a credit counseling agency or a debt counseling agency.” However, he did note that your scores could still be affected if the organization is late making payments.

When you complete the DMP, your balances may be paid in full which can be better for your credit than settling the debts. However, you may be required to close your credit accounts while you’re on the DMP. Your credit scores could drop as a result, although they are very likely to recover as you continue to make on-time payments and decrease your balances.

DMPs can’t include student loans or secured loans, such as a mortgage or auto loans. The organization managing your DMP may also charge a monthly fee, although typically the cost savings thanks to the lower interest rates will far outweigh the total fees.

Which option is best?

There isn’t a clear winner as everyone’s situation is different. However, knowing your options and how they could affect your finances and credit could help you determine what’s best for you.

Want to explore your options with a certified financial expert? MMI offers free financial counseling 24/7, online and over the phone. No judgment, no commitment, just unbiased advice.

Tagged in Debt strategies, Debt settlement, Build your credit score

A corporate headshot of Louis DeNicola.

Louis DeNicola is a personal finance writer with a passion for sharing advice on credit and how to save money. In addition to being a contributing writer at MMI, you can find his work on Credit Karma, MSN Money, Cheapism, Business Insider, and Daily Finance.

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