If you’re considering entering into a debt solution, it is important to understand each option, as well as how it may affect your credit score, how long it is likely to last, and what it entails.
There are a number of different solutions available to those in need of debt help, including debt management plans, IVAs, and bankruptcy. Each of these has its merits, and each comes with its own risks and disadvantages when it comes to obtaining future credit. Let’s take a look at each one in detail.
Credit Score
First, 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.
Equifax says, “A credit score is a tool used by lenders to help determine whether you qualify for a particular credit card, loan, mortgage, or service.” Your credit score is built from your credit history, and is usually expressed by a number between 300 and 999.
The UK does not yet have a uniform credit scoring standard, so these numbers can vary from one credit scoring agency to another. Therefore, we advise you to keep an eye on yours through no more than one or two different credit scoring agencies.
In the US and some other countries, they use a FICO Score, which gives all lenders access to the same information about you and your credit history. It also gives the credit applicant peace of mind, because they know that the FICO Score they have seen is the same that the creditor will see.
Since these scores are not used in the UK, we recommend delving into the details of your credit report, rather than focusing on your score.
Every time you borrow money, buy something on credit, or even just apply for credit, it is noted on your 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. It’s a good idea to take a look at the reasons behind your score drop, so you can understand and 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.
If you are at the point of considering a debt solution, it is likely that your credit score is already quite low, or will become low soon. Since you are already in a situation that sees you unable to repay your debts, the effect that a debt solution will have on your credit score probably won’t be any worse than if you were to continue as you are. Either way, this is how the common debt solutions may affect your credit score:
Debt Consolidation and its Effect on Your Credit Score
Unlike the debt solutions below, a debt consolidation loan combines 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.
These loans are convenient, often require a lower monthly payment, and are not recorded as insolvency. The disadvantages are that the lower payments can often take a lot longer to pay off, the loans can often hold higher interest rates, and if you do not keep up with your repayments, your lender can take action against you.
The key advantage to debt consolidation is that, if you keep up with your repayments each month, your loan can actually improve your credit score. This is because you will pay several lenders off in full and replace them with just one.
It is essential that you do not get behind or default on your monthly payments, though. Lenders will have the right to recover money owed to them through debt collection agencies, and this will be detrimental to your credit score.
Debt Management Plans and How They Can Affect Your Credit Score
If you’re not yet completely overwhelmed by your debt, and you just need a little help, a Debt Management Plan (DMP) can be negotiated by a third party to lower your monthly payments to your creditors.
This debt solution is often used by people who 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.
If you can still manage smaller monthly payments or your circumstances are likely to improve in the future this may be the right solution for you. It avoids the need for an insolvency solution — such as an IVA or bankruptcy — and in many cases, creditors will freeze interest or charges, although this isn’t guaranteed.
A DMP is an informal agreement, and your creditors are not obliged to accept it, which means they have the right to change their minds at any time. A DMP also 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.
A DMP will probably have a negative impact on your credit score, because you will not be making your minimum contractual payments to your creditors, and they are likely to register a default on your account. Your creditors will be able to register multiple defaults if they want, so they could do so for each month that you miss your contractual payment to them. Defaults remain on your credit file for six years.
Debt Relief Orders and How They Can Affect Your Credit Score
Considered the low-cost alternative to bankruptcy, a Debt Relief Order (DRO) is for people with a relatively small amount of debt, no assets, and little to no disposable income. It costs £90 to apply for.
When applying for a DRO, there are some strict criteria to take into account. It’s important to read them carefully before choosing this solution, to ensure that it is the right option for you.
As with any other debt solution, there are advantages and disadvantages to a DRO. This solution lasts for 12 months, so it can be seen as a quicker way of becoming financially free. However, 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, so you will find it extremely difficult to obtain credit for the entire six years, even though the DRO only lasts 12 months.
Individual Voluntary Arrangements and How They Can Affect Your Credit Score
An Individual Voluntary Arrangement (IVA) is a legally binding agreement between you and your creditors. It is a debt solution that offers protection from further action, such as collection agencies, bailiffs, and county court judgements (CCJs).
If you want to enter into an IVA through Debt Movement, one of our licensed Insolvency Practitioners will set up the contract for you, and help you 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?
Because of the nature of an IVA, it will be listed on the Individual Insolvency Register, and the default registered at the start will remain on your credit report for six years. While you are in your IVA, you will not be allowed to obtain any further credit without the permission of your IVA Supervisor, so the impact on your credit file during this time should be minimal.
Since your IVA is likely to last five to six years, by the time it is completed, the default registered at the start will either already have come off your credit file or be just about to, and you can make a fresh start, financially free.
Here at Debt Movement, we have helped over 35,000 people, just like you, get on the road to financial freedom. Our friendly and impartial guides will help you to decide which is the right debt solution for you. Request a free callback today, and we can help you begin your journey to financial freedom.
Knowing which debt solution to choose can be confusing and overwhelming, so please contact our non-judgmental team at Debt Movement for caring and understanding debt guidance.
