Debt management plans (DMPs) effectively allow individuals to regain control over their finances and pay off their debts. These plans typically involve regular payments to a debt management company, which distributes the funds to the individual’s creditors.
However, one concern that people often have when entering a DMP is its impact on their credit score. While it is true that entering a DMP can have a negative effect on credit, it is crucial to understand that there are steps that can be taken to mitigate this impact. One such measure is to establish new credit while on a DMP.
New credit refers to any new loans or lines of credit that an individual takes out while on a DMP. This can include personal loans, credit cards, or even a new car loan. While it may seem counterintuitive to take on new debt while working to pay off existing debt, there are several benefits.
First, establishing new credit can help to improve an individual’s credit utilization ratio. This ratio measures how much of an individual’s available credit they are using. Generally, it is recommended that individuals use at most 30% of their available credit at any given time. By taking out new credit, individuals can increase their available credit, which can, in turn, lower their credit utilization ratio.
Second, establishing new credit can help to diversify an individual’s credit mix. Credit mix refers to an individual’s different types of credit, such as credit cards, car loans, and mortgages. A diverse credit mix is seen as a positive factor when calculating credit scores, as it indicates that an individual can manage different types of debt responsibly.
Finally, establishing new credit can help to show creditors that an individual is committed to improving their credit and managing their debt responsibly. When applying for new credit, individuals should explain that they are on a DMP and provide evidence of their regular payments. This can help reassure lenders that the individual is taking their financial responsibilities seriously and can make payments on time.
Of course, it is important to approach new credit with caution while on a DMP. Individuals should only take on new debt if they can make the payments on time and in full. They should also be sure to shop around for the best rates and terms, as high-interest rates or hidden fees can quickly undermine the benefits of new credit.
In addition, individuals should be aware that taking on new credit can temporarily negatively impact their credit score. This is because new credit applications result in a hard inquiry on an individual’s credit report, which can lower their score by a few points. However, this impact is usually minor and is outweighed by the long-term benefits of establishing new credit.
They are establishing new credit while on a DMP can be a smart way to improve one’s credit score and demonstrate a commitment to responsible financial management. By diversifying one’s credit mix and increasing available credit, individuals can help to offset the negative impact of a DMP on their credit score. However, it is essential to approach new credit cautiously and only take on debt that can be managed responsibly.