Why Enrolling in a Credit Counseling Program Can Hurt Your Credit Score

I keep seeing information around the web by credit counseling companies saying that enrolling in a credit counseling program does not hurt your credit score. I believe the reason they say this is because the enrollment into the credit counseling program is not viewed as a negative entry in the calculation of the credit score. But the statement that placing accounts in a credit counseling program will not alter, hurt or reduce the credit score is not true.

My assertion has been that while the enrolling in the program may not ding the credit report, when a consumer enrolls in the program the creditors will close their credit cards included in the program and that is what can lower the credit score.

Well I finally had an opportunity in researching another issue to get an official statement from FICO, the leader in credit score calculations, about this issue.

The example I sent to FICO was for them to help me to understand how the credit score would be impacted if a consumer had open accounts versus closed accounts. Consumer A – 5 accounts open for 6 years. Accounts still open and active. Consumer B – 5 accounts closed for the last 2 years but had been open for 6 years prior to closure.

All other things being even, would the score calculated today for Consumer A be the same or higher than the score calculated for Consumer B?

I told FICO that a Credit Counseling and DMP group was asserting that placing accounts in a debt management program does not hurt the consumer credit score.

Here is what Craig Watts, the spokesperson for FICO says:

The FICO algorithm does give more weight to recent credit activity. Taking that one step farther, if in your example those were the only credit accounts for consumer B, she likely wouldn’t have a FICO score at all now. Minimum requirements for calculating a FICO score are that the credit report must contain at least one account at least 6 months old, contain at least one account that has been updated by the creditor within the previous 6 months, and have no deceased indicator. If consumer B’s accounts have all been closed at least 2 years, her credit report almost certainly won’t satisfy that second condition.

Other factors come into play too. Roughly 30% of a FICO score consists of “amount owed” factors, and a significant piece of that action is credit utilization rate. The algorithm assesses the utilization rate of each open and active revolving account, and separately of all such accounts in aggregate. Closing an account usually removes it from that calculation and can change the aggregate utilization rate. That isn’t sufficient reason to keep an account open, mind you, if the person will rest easier if it’s closed. But it’s another way that closing a revolving account can affect the person’s score.

Going back to your original question, the credit counseling company asserted that 1) accounts once included in DMP and now closed by creditor will have no impact on credit score, and that 2) a DMP will improve a credit score.

Assertion 1 is incorrect since the closed accounts will continue to influence the score’s assessment of length of credit, and the ABSENSE of the accounts from the credit report could influence other factors such as credit utilization rate.

Assertion 2 is incorrect since a DMP is not a single event but an umbrella for a variety of credit actions over some length of time, each of which will influence the person’s credit score when lenders report them to the credit bureau. The impact of each credit action on the score will depend on the action itself and on the other information present on the credit report. Therefore while a DMP may in aggregate improve the person’s score, it also may lower the person’s score. I would be willing to say that a DMP will improve a credit score only if the DMP is restricted to two type of actions: paying all bills on time as agreed, and paying down existing credit obligations. If the DMP includes any other actions — including closing accounts — we can no longer generalize about whether the DMP will improve the person’s score.

Hopefully this will finally clarify this issue for everyone.

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Update 8-25-2012

While credit counseling groups are generally quiet on this issue or make claims a debt management program does not impact your credit, at least one group makes an admission that closing account does hurt your credit.

In a Time magazine article on August 20th the following quote appeared.

“Many people believe that keeping credit cards they don’t use is a liability to their credit score, so they close them. In fact, hanging on to cards that you rarely or never use can boost your score.

“A key component of your score is to practice self-control from tapping into all of your available credit,” says Dorothy Barrick, a group manager and financial counselor at GreenPath Debt Solutions. Lenders want to see that you have access to credit but the financial discipline not to exploit it. Closing open accounts will actually hurt your score by skewing your credit utilization ratio, which is the percentage of your available credit being used at any given point. “The smaller the percent, the healthier your score will be,” Barrick says.” – Source


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Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.
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