How Debt Counseling Affects Your Credit Score

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No doubt one of the reasons you are considering debt counseling is to protect your financial profile. The good news is that, according to FICO, they do not take into consideration whether you are participating in any sort of credit counseling when calculating your score. But there are ramifications from this decision that can affect your credit score. Here's what to consider:

What negatively impacts your credit score

It is critical to choose a reputable credit counseling agency that pays your bills on time, as late payments will adversely affect your credit score. In addition, you will be required to close credit card accounts when you begin the counseling program. This will temporarily lower your score because you are lowering your overall credit utilization ratio (percentage of available debt versus actual debt) and possibly closing long-standing accounts.

Keep in mind that lenders examine your credit report before approving loans, and the fact that you are in a debt counseling program may negatively color their decision about whether to lend you money. But it's best that you avoid loans anyway, and some credit counseling programs may require that you do just that.

What positively impacts your credit score

Debt counselors can negotiate with creditors for you and are often able to bring your accounts current, which positively affects your score. Of course, the biggest boost to your credit score will be getting out of debt. So the more loans you pay off, especially credit cards with high balances that are close to the limit, the higher your credit score will rise, eventually making the possibility of receiving new loans more likely.

While it may not affect your credit score initially, the counseling agency can sometimes negotiate a lower interest rate on your debts, lowering your overall monthly payment and helping you get out of debt sooner.

The passage of time and good credit habits after you finish the program are the most beneficial to maintaining a good credit score, but repairing your financial profile is a long-term commitment anyway. While credit counseling does have its consequences, including an effect on your credit, any temporary dip in your score is well worth the prospect of getting out of debt permanently.

Julie Bawden-Davis is a Southern-California-based writer specializing in personal finance and insurance. Since 1983, her work has appeared in a wide variety of publications, including Family Circle, Ladies' Home Journal, Parenting, Entrepreneur and The Los Angeles Times.