How Does A Debt Management Plan Affect Applying For Loans?

Although it’s not impossible, it may be very difficult to be approved for a new loan if you’re currently enrolled in a debt management plan (DMP). Lenders may scrutinize your application more closely to ensure your circumstances — like your income and debt-to-income ratio — have improved to the point that they feel comfortable lending to you.

“Many of our clients have successfully improved their credit while on a DMP, which can help them qualify for loans and achieve greater financial stability,” says Becky House, a director at nonprofit counseling agency American Financial Solutions (AFS). “However, whether someone can obtain a loan depends largely on their individual credit profile.”

So, while it is possible to get a loan while on a DMP, you may need to jump through extra hoops to prove you can handle additional debt.

Can you get a loan while on a debt management plan?

Lenders typically won’t deny your loan application strictly because you’re enrolled in a debt management plan or were in the past. However, being on a DMP can impact your eligibility in a few scenarios:

• If your particular DMP agreement forbids you from taking on new credit before your repayment plan is complete.
• If a lender lessens (or “charges off”) your debt balance as part of your DMP and reports this action to the credit bureaus, damaging your credit report and score.
• You recently enrolled in the DMP and lenders want to see a longer history of making payments within the plan before giving you new credit.

When evaluating your loan application, lenders might see a note on your credit report that you’re enrolled in a DMP. House, who has worked for AFS since 2001, says the language could be something like, “Account being paid through a third party.”

Recent delinquencies and low credit scores may mean you only qualify for bad credit loan rates while on your debt management plan. The higher your quoted interest rate, the more expensive it is to borrow.

Higher payments on new debt could also squeeze your budget, reducing your odds of being able to afford ongoing debt management plan payments. Consider the following scenarios of borrowing a $10,000 personal loan with a five-year repayment term.

Even a 10 percent change in interest has a large impact on how much you pay. Waiting until you have finished your debt management plan and improved your credit score may help you save thousands of dollars in interest over the life of a loan.

Personal loans

You may find a wide variety of personal loan lenders willing to approve you for financing while you’re enrolled in a DMP, since many offer options for borrowers with bad credit. You may pay personal loan rates as high as 36 percent, even from reputable lenders.

Be especially vigilant about fees, which may be much higher if your credit score is low. Most will require good credit, stable income and a low debt-to-income ratio if you want a lower rate or a longer repayment term (which is usually capped at seven years).

You may get a better rate or improve your approval odds with a qualified cosigner or if you seek out a secured loan that prioritizes your collateral (such as a car or home) over your credit standing.

Auto loans

Like personal loans, you may be relegated to a bad credit auto loan while enrolled in your DMP. That means you’ll likely end up with double-digit rates and may be limited to shorter repayment terms. However, if you’re towards the end of your debt management plan and your credit scores have improved, you might eke out a rate below 10 percent.

Auto loan companies may also offer prequalification or preapproval. Preapproval may help you the most because it allows you to act like a cash buyer when negotiating at a dealership. In addition, a large down payment can also strengthen your auto loan application and reduce the amount you need to finance.

Student loans

Most types of federal student loans, with the exception of Parent PLUS Loans, don’t require a credit check. That improves the odds of getting approved for new loans, even if you’re currently paying on a DMP.

Private student loans, however, are credit-based. Banks, credit unions and other lenders rely on your credit history, among other financial factors, and like personal loans, your rates will be higher with lower credit scores.

Mortgages

Home loan lenders may offer some flexibility with DMPs if you’ve made payments on time for several months or years. The requirements may vary depending on the lender. Government-backed loans tend to offer the most leniency, since they are supported by government agencies like the Federal Housing Administration and Veterans Administration.

Be prepared to write letters of explanation for what led you to enroll in the program. You’ll also need to make the case for why you can afford a long-term loan like a mortgage. Finally, be prepared to document your payment history with a payment schedule from the DMP company to prove you’ve kept everything on time.

“You’ll have a better shot at getting the thumbs up on a new mortgage if you’ve been making payments on [your DMP] plan for a few years, or are towards the end of the plan,” says Denny Ceizyk, Bankrate loans expert and a former mortgage originator. “Mortgage lenders may look favorably at DMP because it’s a sign that you tried to make good on your debts, rather than discharging them in a bankruptcy.”

How does a debt management plan affect your credit?

When you establish a debt management plan, you’ll likely be asked to discontinue using your credit cards. Closing or deactivating these accounts can cause short-term harm.

“While this may cause an initial dip in your credit score, the primary goal of a DMP is to help you make consistent, on-time payments, reduce your balances and get out of debt,” says House. “Over time, these positive behaviors typically contribute to improving your credit scores.”

It’s important to note there’s a big benefit to being proactive with debt. If you realize you’re in over your head, consider setting up a DMP before you start missing payments. This way, you might dodge much of the negative impact to your credit.

“We have many clients who complete a DMP and tell us how much their credit has improved during that time frame. We have new homeowners, people who make auto purchases, and those who do take on additional debt all while staying on track with the DMP.”

Once your debt management plan is finished, you can take steps to improve your credit score. If borrowing a loan isn’t immediately necessary, this can help you score a lower interest rate — and over time, on-time loan payments will contribute to a better score.

Alternatives to a debt management plan

Before resorting to a debt management plan, consider other forms of debt relief that might have less of an impact on your borrowing ability and credit score.

• Talk to your creditors
  

  If you’re worried about missing debt payments, you aren’t obligated to enroll in a DMP or even speak to your lenders through a credit counseling service or debt relief company. You can reach out to your lenders directly to discuss your situation.

  You might ask about the lender’s repayment relief options, potentially including:

  • Waived fees.
  • Accepted late payments or potential grace periods.
  • Changing your payment due date.
  • Temporarily deferring (or pausing) payments.

  Getting back on track without relying on a debt management plan could put you in a better position to borrow again, and quicker.

• Debt consolidation
  

  Consolidating your debt means taking on a new, usually unsecured, personal loan to replace your existing accounts. As a result, you will have a single monthly payment to one creditor. Not only does this make keeping up with payments easier, but you will also lower your credit utilization ratio, which can help improve your credit score.

  Debt consolidation can lower your monthly payment (if you extend your repayment term) and potentially lower the interest rate of your debt (if your credit has improved since you previously borrowed). Without strong credit, you could apply for a loan with a cosigner.

  This might be a good alternative to borrowing a loan while enrolled in a DMP. After all, you could apply for a larger debt consolidation loan than you need to cover your existing debt, then use the remaining funds for your needed purpose.

• Debt settlement
  

  Some lenders might opt to settle your debt if they believe you have no realistic path forward to repayment. While paying less than you owe might sound like the ideal alternative, it’s not an option for many borrowers. And even if it is, settlement carries the same consequence of a DMP: Your credit score could suffer (at least temporarily), making it more difficult to qualify for a new loan in the near future. You may also owe taxes on settled debt, which may further increase your financial burden.

  In addition, debt relief companies that specialize in negotiating settlements charge fees that go far beyond the comparatively minimal expense of a DMP. You can settle your debt yourself by contacting your lender and negotiating, but the result will be the same. If the lender does agree to settle, the charged off accounts will still be reported to one or more of the major credit bureaus.

Bottom line

A debt management plan can indirectly hinder your credit and, as a result, your new loan application. However, it’s possible to get a loan while enrolled in the typical three-to-five-year repayment plan of a DMP.

Whether it’s wise is another story.

“While we understand the need for loans in certain situations and can even provide a [recommendation] letter to assist clients when applying, we generally encourage avoiding new loans or credit cards while on a DMP,” says House. “Based on feedback from our clients, we know some do take on new loans or credit during their time with us. We hope their experience with the DMP helps them make more informed decisions and avoid future financial challenges.”

If you’re still considering talking to a counselor about DMPs, consider the Department of Justice’s list of approved agencies.