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How Do Debt Solutions Affect Your Credit Score?

When looking into debt solutions, it is important to understand each solution, how it may affect your credit score, how long it is likely to last and what it entails. There are varying degrees of help available when in need of a debt solution, from a debt management plan to an IVA or bankruptcy. Each has its own merits and comes with its risks and disadvantages when it comes to obtaining future credit. Let’s take a look at each in detail. 

What Is a Credit Score?

Before delving into each debt solution and its effects on your credit score, let’s take a look at what a credit score is, how it is used by lenders and how you can use it to monitor your financial situation.

According to Equifax, “A credit score is a tool used by lenders to help determine whether you qualify for a particular credit card, loan, mortgage or service.”  It is built from your credit history and tends to be a number between 300 and 999. Since the UK does not yet have a uniform credit scoring standard, these numbers can vary from one credit scoring agency to another, so it is advised to keep an eye on yours using one or two different credit scoring agencies.

Countries like the US use a FICO Score, this gives all lenders access to the same information about you and your credit history. It also gives the credit applicant peace of mind knowing that the FICO Score that they have seen is the same that the creditor will see. Because these scores are not used in the UK, we recommend delving into the details of your credit report rather than focusing on your score.

Each time that we borrow money, purchase something using credit or even just apply for credit, it is noted on our credit report, and your score will be adjusted appropriately. If you borrow a lot in a short period, borrow more than your credit limit or miss repayments, your credit score will be negatively impacted. For this reason, it is a good idea to take a look at the reasons behind your score drop to rectify them.

This can of course be difficult when you are struggling with debt and considering a debt solution to help you get back on track. 

It’s important to understand that if you are at the point of considering a debt solution, it is likely that your credit score is quite low or will become low regardless. It is also important to understand that you are probably in a situation that sees you unable to repay your debts, so the effect that a debt solution will have on your credit score itself may be unlikely to be any worse than if you were to continue as you are.

What Is Debt Consolidation and How Can It Affect Your Credit Score?

A debt consolidation loan is used to combine multiple debts (such as store credit, credit cards and overdrafts) into one loan to lower the monthly repayment amount and put less stress on your finances.

A debt consolidation loan is convenient, often requires a lower monthly payment and will not be recorded as an insolvency. However, the disadvantages are that the lower payments can often take a lot longer to pay off, they can often hold a higher interest rate, and if you do not keep up with your repayments, your lender can take action against you.

In terms of how this type of loan can affect your credit score, the truth is that if you keep up with your repayments each month, a debt consolidation loan can actually improve your credit score. This is because you will pay several lenders off in full and replace them with just one. You must be careful that you do not get behind or default on your monthly payments, though. Lenders will have the right to recover the money owed through debt collection agencies and this will be detrimental to your credit score.

What Is a Debt Management Plan and How Can It Affect Your Credit Score?

A Debt Management Plan, or DMP, is different from debt consolidation in the sense that it is usually negotiated by a third party to lower your monthly payments to your creditors. This is a debt solution that many use when they are beginning to struggle to meet the minimum payment amounts for their debts or have missed a few repayments and want to get back on track.

It’s a good debt solution for those who can still manage smaller monthly payments or whose circumstances are likely to improve in the future. It avoids the need for an insolvency agreement such as an IVA or bankruptcy and in many cases, creditors will freeze interest or charges, although this isn’t guaranteed.

Your creditors are not obliged to accept a DMP though, it is an informal agreement, so they do have the right to change their minds at any time. Additionally, it does not offer protection from creditor/bailiff action, and your home and assets will not be protected if you fail to keep up with repayments.

In terms of how a debt management plan will affect your credit score, the reality is that it will probably have a negative impact as you will not be making your minimum contractual payments to your creditors who are likely to register a default on your account. Creditors are able to register multiple defaults if they choose to, for each month that you miss your contractual payment to them. Defaults remain on your credit file for six years.

What Is a Debt Relief Order and How Can It Affect Your Credit Score?

A Debt Relief Order (DRO) is considered a low-cost alternative to bankruptcy.  It is for people who have a relatively small amount of debt, no assets and little to no disposable income and costs £90 to apply for.

There are some stricter criteria when applying for a DRO, so it’s important to read them carefully to ensure that a DRO is the right option for you. Before you apply though, it’s important to understand that, as with any other debt solution, there are advantages and disadvantages.

A DRO lasts for 12 months, so this can be seen as a quicker way of becoming financially-free, but you must remember that your details will be added to the Individual Insolvency Register and the default registered at the start of the DRO will remain on your credit file for six years. This will have a negative impact on your credit score, meaning that you will find it extremely difficult to obtain credit for the entire six years even though the DRO only lasted 12 months.

What Is an IVA and How Does It Affect Your Credit Score?

As a legally binding agreement between you and your creditors, an Individual Voluntary Arrangement (IVA) is a debt solution that offers protection from further action such as collection agencies, bailiffs and county court judgements (CCJs). 

Here at Debt Movement, a licensed Insolvency Practitioner will set up the contract for you, helping you to work out affordability based upon your circumstances. You will never pay more than you can reasonably afford. Once your IVA term is completed, you will receive a certificate of completion and your debt will be written off. 

So, what affects your credit score when it comes to an IVA?

An IVA will be listed on the Individual Insolvency Register, and the default registered at the start will remain on your credit report for six years. During the time you are in your IVA you will not be allowed to obtain any further credit without the permission of your IVA Supervisor anyway, so the impact to your credit file during this time should be minimal to you. As your IVA usually lasts five to six years, by the time it is completed, the default registered at the start will have come off your credit file and you can make a fresh start, being financially free.

Debt Movement have helped over 35,000 people just like you to get on the road to financial freedom. Our friendly and impartial guides will help you to decide whether an IVA is the right debt solution for you. Request a free callback today, and we can help you begin your journey to financial freedom.

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