I was told by my credit counselor that I had to shut down my accounts before using their plan to pay my cards. But isn't closing cards bad for my credit? I'm behind $27,000 to three separate cards with APRs of 20 percent and above. The interest rates the counseling agency says it can give me are way better than the ones I have now. How do I know if the money I save is worth any damage to my credit? – Jack
I have a strong suspicion that your credit reports — and thus your credit scores — have already taken a painful punch. You owe nearly $30,000 in consumer debt, which is certainly a substantial sum. That alone acts as a warning to other lenders that you're overextended. If your balances are at or near your credit limits, your credit scores are suffering. Additionally, if you've been making partial payments or have even missed some billing cycles, those scores that you want to preserve are already in trouble.
You're right that closing an active line of credit can shave some digits off a FICO score, yet it's a minor factor compared to the problems I described above. However, even more significant than the numbers of a credit score are the numbers in a bank account and wallet. You're hemorrhaging money, Jack. If I were you, I'd sacrifice some credit score points to stem the flow.
High interest rates are resulting in massive amounts of cash going toward finance fees rather than the principal. For example, if your credit cards have an average APR of 20 percent and you delete the entire obligation in three years, you would pay just over $9,000 in interest. Slash the amount of time in half, though, and the total fees would be around $4,400. Still a terrible waste of funds, but a big savings. Is saving $4,600 worth a few credit score points? I think so.
Now on to what the credit counseling agency can and can't do.
Nonprofit credit counseling organizations can arrange a payment plan to get you out of debt within five years. You send them the money, and they distribute it to your creditors, who in turn reduce the interest rates (not all will, but many do). If you sign up, you agree to close the accounts so you don't get further into the hole. As your debt decreases and your payment pattern steadies, your credit rating will increase.
What a credit counseling agency can't do is force you to change for the better. So if you don't pay as agreed, your credit rating will decline — the same as it would if you handled the accounts on your own, forgot to pay and let the debt linger.
A credit counseling agency doesn't send any information to the credit bureaus, but some credit issuers add a note that you're paying through a third-party service. This notice is not factored into a credit score at all, so it has no effect on your FICO score. As for your report, anyone who pulls it will see evidence (again, if your creditors do report) that you're using a service and are free to form their own opinion about it. Some lenders mind, others don't.
Bottom line, Jack, is that you should get rid of that debt as quickly as you can. It's too expensive to hold on to. If you'd rather do it yourself, try to get the creditors to reduce their rates for you so you won't be socked with so much accumulated interest. And put the cards on ice, too. You don't have to close them as you would with a credit counseling agency's plan, but at least make a commitment to not use them while you're in repayment mode.
Evidence that you've eliminated the debt and have paid on time will create a great credit rating — whether you do it on your own or with help.
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