Credit Score Perils of Debt Consolidation

What happens to your Credit Score in Debt Consolidation?

A bad economy is a boom for the debt consolidation industry. They have a reputation as being non-profit, helping to prevent bankruptcy and fighting for the little guy. But, there are some nasty side effects you should know about.

What happens to your Credit Score?There are four big problems with most debt consolidation programs:

1. FEES. Your payments go to fees first. In fact, for the first 6 to 8 months of a 24 month program, 100% of your payments can go to fees (the ‘fee period’). After this fee period, you still pay a monthly management fee for the remainder of the program.

Sure, your creditors are put on notice that you are in a debt program at the beginning, however, that means nothing. They are not legally obligated to wait until your fee period has ended, nor stop collections. Fees and interest still accumulate.

2. NO NEGOTIATION. There are NO negotiations with your creditors until you complete the ‘fee period’. Your creditors are left in the dark and ignored by your debt managers. This is bad for them and for you.

As a result, your creditors do not stop collection attempts. The phone calls and letters keep coming. They even sell the debt to collectors who can get more aggressive in their collection attempts.

Liens, lawsuits, wage garnishment and asset seizures can still occur during this fee period. Some debt consolidation programs will charge you an extra fee to intervene at this point, but by then it may be too difficult and too late.

When your ‘fee period’ is done, you have to help the debt consolidation company identify which collection agency bought your debt. It can go from your creditor to several collectors during your fee period.

3. CATASTROPHIC CREDIT SCORE. Because there are no payments or negotiations with your creditors during this ‘fee period,’ your credit score goes from bad to catastrophic. This is the real problem. It takes a lot longer to get back to a normal credit score. Why? Because during your ‘fee period’ your creditors and collectors continue to report ever worse negatives on your credit reports.

In some cases, your credit score recovery is faster from a bankruptcy filing as opposed to waiting until a debt consolidation program ends. Naturally, everyone’s situation is different and I am not necessarily recommending bankruptcy.

4. TAX PROBLEMS. In some cases, creditors are required to file a tax gain on your debt reduction from a formal debt management program. Imagine saving $10,000 in your debt program, yet you have a $4,000 tax bill. Ugh!

Strongly consider your options before you enter in to a debt management program.

As an alternative, I recommend the Action buttons.

Use our Debt Settlement action to negotiate directly with your creditors to reduce your debts one-by-one or ask to defer for several months of payments. It works fast and you’re in direct control.

If you have good credit, use our Interest Rate Reduction action to get more competitive rates.

David B. Coulter – founder and CEO of Smart Credit