Ask YOUNG MONEY: Can credit counseling hurt my credit rating?

The amount of misinformation that exists regarding credit counseling is just amazing. Here's an example of poor advice offered in a recent Motley Fool article.

Question: Should I use consumer credit counseling organizations to help me get out of debt? Do they have any drawbacks? - C.R., Indianapolis

Answer: Be careful with such outfits. Using them can do serious harm to your credit rating. If your credit report reflects that you've sought professional help, it can decrease your credit score significantly - sometimes as much as a bankruptcy can. Worse, while you proceed to dig your way out of debt (and sometimes for years afterward), many mortgage lenders won't consider you for a loan.

I answer this question several times each week. This article is giving very bad and seemingly uninformed advice.

Besides being wrong about the effect of credit counseling on the credit score, what the writer doesn't consider is the very reason the person is seeking credit counseling help to begin with. The writer assumes the person they are advising has good credit. But, if a person is considering credit counseling, they are already behind on payments meaning their credit has been damaged. This damage, depending on how bad it is, is what will affect the person's ability to qualify for a mortgage loan or other loans and credit. Not the fact that they have enrolled in credit counseling.

According to the creators of the FICO Score, Fair Isaac, Co., being enrolled in credit counseling has no effect on your credit score whether positive or negative. It is not factored into the FICO credit score calculation. Late payments, charge-offs, and other negative information will be reported for 7 years and lenders will use that information to make loan decisions. Credit counseling is designed to help a consumer get late payments caught up and pay down debt. Both of those activities will help boost a credit score.

Put yourself in the lender's shoes. The consumer applies for a loan while they are enrolled in credit counseling to get help repaying problem debts. Would you give them a loan? No, but not because they are in credit counseling, but because they are having trouble repaying their current debts. They would get the same response from a lender if they applied for a loan with the same credit problems but not enrolled in credit counseling. The bottom line is this, if you need help to get out of debt, get the help. You should not be applying for loans while you are digging out of problem debt anyway.

One last thing; once you repay your debts and graduate from a credit counseling program, any notations in your credit file about being enrolled in credit counseling should be removed since it would no longer be true. You should graduate from a credit counseling program with better credit than when you started.

Mike Schiano
 
© 2008, Young Money Media, LLC. All rights reserved.

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