Does a debt management plan affect credit score?

Are you struggling to manage your debt and improve your credit score? If so, a debt management plan (DMP) might be the solution you've been looking for.

In this blog, we will explore how a DMP in Canada works, its benefits, and its impact on credit scores.

We'll also introduce the credit building help available with KOHO. Read on to take control of your financial health and start your journey towards a debt-free future.

What is a Debt Management Plan (DMP)?

A debt management plan, or DMP for short, is a program designed to help individuals manage their debt effectively. It involves consolidating multiple debts into a single monthly payment, making it easier to keep track of and manage finances.

There are various types of DMPs available, each tailored to suit different financial situations.

How a DMP Works

Setting up a debt management plan in Canada involves several steps. First, individuals seeking to establish a DMP work with a credit counselling agency to assess their financial situation and determine if a DMP is the right option for them.

If it is, the agency negotiates with creditors to lower interest rates and create a manageable repayment plan.

Once the DMP is in place, individuals make a single monthly payment to the agency, which then distributes the funds to creditors. This debt management and consolidation — and potential reduction in interest rates — can help individuals regain control over their finances.

Let's consider an example to illustrate how a DMP works.

Imagine you have $10,000 in credit card debt spread across multiple cards with varying interest rates. With a DMP, you can consolidate these debts into a single monthly payment, potentially lowering your interest rates and saving you money over time.

This makes managing your debt more manageable and allows you to make progress towards becoming debt-free.

Does a DMP cost anything to set up?

Many credit counselling agencies and organizations that offer DMP services charge setup fees and monthly when you enroll in a debt management plan.

These fees can vary, and they’ll often be folded into your DMP payment.

According to Money Management International in the United States, the average DMP cost $33 to set up and $24 per month in 2022.

Benefits of a DMP

One of the main benefits of a DMP is the reduction of stress that comes from managing multiple debts. By consolidating your debts into one manageable payment, you can focus on making progress towards paying off your debt rather than worrying about juggling multiple payments.

Additionally, a DMP can help you avoid more drastic measures such as filing for bankruptcy, which can have long-term negative consequences.

Another advantage of a DMP is the potential for lower interest rates. Through negotiations with creditors, the credit counselling agency may be able to secure lower interest rates, saving you money and helping you pay off your debt faster.

Overall, a DMP can provide you with a clear path towards better financial management and help you achieve your goals of becoming debt-free.

What is bankruptcy?

Bankruptcy is a legal process that provides individuals and businesses with a way to seek relief from overwhelming debt when they are unable to pay their creditors.

Filing for bankruptcy involves working with a Licensed Insolvency Trustee (LIT) to assess one’s financial situation and discuss options.

The LIT helps the debtor prepare and file the necessary paperwork, including a list of all the filer’s assets, liabilities, income, and expenses.

Once bankruptcy is declared, creditors are prevented from taking further collection actions, such as lawsuits, wage garnishments, or repossessions.

The debtor's non-exempt assets may be sold, and the proceeds are used to pay off a portion of their debts.

The debtor is eventually discharged from bankruptcy, typically after nine or 21 months, depending on their situation and whether they have been bankrupt before. Once discharged, the debtor is released from most of their unsecured debts, and they can make a fresh financial start.

While bankruptcy can provide relief from overwhelming debt, it also has lasting consequences, including a negative impact on the debtor's credit score and report for several years.

Does a DMP Affect Credit?

Many individuals considering a DMP are concerned about its impact on their credit score. Credit score and debt management are closely intertwined.

In the short term, enrolling in a DMP may have a temporary negative impact on your credit score.

However, as you make regular payments and demonstrate responsible financial behavior, your credit score can begin to recover.

It's important to remember that having a DMP in place shows lenders and creditors that you are taking proactive steps to manage your debt, which can be viewed positively in the long term.

While using a DMP, it's essential to understand how debt affects credit scores. Timely payments and responsible financial behaviour can help maintain or improve your credit score over time.

It's also recommended to regularly monitor your credit report and work on building good credit habits while utilizing a DMP.

Credit Building Help with KOHO

At KOHO, we understand the importance of credit scores and offer assistance in credit building. KOHO is a financial platform that provides a range of tools and resources to help you improve your credit score and achieve your financial goals.

With KOHO, you can easily track your expenses, set budgets, and receive personalized tips to improve your credit score.

You can even enroll in a monthly credit-building program that reports directly to Equifax.

We believe in empowering individuals to take control of their financial health. That's why we encourage you to explore additional KOHO credit-related guides and blogs, where you'll find valuable insights and strategies to boost your credit score.

With the right tools and resources, you can build a strong credit foundation and secure a brighter financial future.