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A Debt Management Plan (DMP) is effectively a means of rescheduling your debt repayments in the short, medium or longer term. A DMP tends to occur where an individual has seen a reduction in their disposable income and is unable to cover the previously agreed monthly payments. As with any type of debt default, this type of plan will have an impact on your credit score but perhaps not to the extent that many people automatically assume.
How is your credit score calculated?
Before we look at how a DMP can impact your credit score it is worth reminding ourselves of what your credit score reflects. In very basic terms, each credit payment you make on-time creates positive action and each credit payment you miss creates a negative action. There are additional factors to take into consideration when calculating individual credit scores but that is the theory of the system.
There are currently three credit rating agencies operating in the UK who have their own individual criteria and means of calculating credit scores. They may interpret various positive and negative actions slightly differently but in general, they will arrive at the same conclusion.
The road to financial recovery
Ironically, a DMP agreement with your creditors is to all intents and purposes the first step on your road to recovery. The likelihood is that you will already have defaulted on one or more debt repayments before even contemplating a debt management plan. So, for many people, the damage has already been done to their credit score.
It is worth noting that while plans are very useful and a common means of rescheduling debt repayments, they are informal and not legally binding. As a consequence, any party can withdraw from a DMP at any stage although obviously there may be repercussions with regards to additional action to recover outstanding debts. The short term goal when undertaking a debt management plan is to abide by the agreed repayment schedule and look to rebuild your credit score in the medium to long term. A good credit score is essential, especially if for example the purchase of a home is in your long-term plans.
Missed payments and your credit score
Your credit record will show a rolling six years of payments across all of your credit arrangements. In the event that you miss a payment or are unable to afford the full payment could lead to a default. However, it may not necessarily be marked on your credit record immediately. For example, if you were to miss a loan repayment then the initial payment would be noted as one month late, the next month the first missed payment will show as two months late and the next payment one month late. If this was to continue for between three and six months then the lender would probably look to apply a default tag to your credit record.
The impact of a debt management plan
There are many different factors to consider with regards to a DMP and your credit score. For example, even though a DMP could see creditors freezing interest and charges they will still classify reduced payments as missed payments and then defaults. The whole point of the credit scoring system is to reflect the recent financial history of an individual as a reference for other lenders. It can also be used as a reference point for third parties such as landlords, although specific consent would be required, where an individual is seeking a tenancy agreement.
As creditors will add a default reference usually after three missed or partial payments, it is likely that debts involved in your DMP will be noted accordingly at a relatively early stage in your financial recovery. While the default reference will remain on your credit file for a further six years, the sooner the clock starts ticking the better in terms of rebuilding your long-term credit score.
Reviewing DMP payments
There are a number of subtle differences with regards to DMP payments compared to IVAs and bankruptcy. For example, creditors can at any time request a review of your income and expenses and subsequent disposable income. Where there has been an increase in disposable income this can lead to an increase in regular payments. Subsequently, a reduction in disposable income could see future DMP payments revised downwards. It is in the best interests of all parties to agree on affordable payments so that:
- Creditors are eventually paid in full
- Repayments are realistic for the individual
- The individual can eventually draw a line under their financial troubles
If you foresee any difficulties in fulfilling your agreed DMP payments you should advise your creditors as soon as possible. Those unable to cover DMP payments going forward will likely see creditors removing themselves from this informal arrangement and taking formal action.
How do future lenders view DMPs?
It is safe to say that any missed contractual payments will be frowned upon by lenders. So, rather than regular monthly missed payment markers, eventually leading to default notices, it makes sense to arrange a DMP. Even though reduced payments will be noted on your credit file (and still prompt default notices) this period of reduced payments should help you get back on your feet and eventually exit your agreement. After a six-year period, missed payments and default notes will be removed from your credit records. While lenders will take into account historic financial activity/issues they are more interested in a recent activity which reflects your current situation.
There are occasions where a DMP may only be required for a relatively short period of time; perhaps you are between jobs, while some may be extended to the medium term and others indefinitely. There is no hard and fast rule regarding the term of a DMP because by definition they will reflect not only your debts but also your ability to pay going forward. It is also worth noting that the impact of historic defaults/missed payments on your credit score will be diluted going forward – even prior to the eventual removal after six years.
Credit arrangements impacted by DMPs
In general, if you have experienced financial defaults you should expect difficulties in obtaining any type of credit. Various services which you would not normally class as credit arrangements may prove more difficult including:-
– Renting
When you sign a tenancy you are committing to a set term and regular rental payments. Therefore, it will come as no surprise to learn that the majority of landlords will access your credit file but only after your consent. While a low credit score will not help your situation there could be ways and means around this. For example you may be expected to put down a larger than normal deposit which would give the landlord a degree of flexibility if you began to experience financial difficulties.
– Mortgages
Unless you already have a mortgage agreement in place it may be likely that you would struggle to agree on mortgage funding while in a DMP. There are obvious risks to lenders and creditors may request additional payments if, in theory, you are able to afford mortgage repayments.
– Remortgaging
When looking to reorganise your debts, remortgaging your home is something that creditors would consider at an early stage. Due to a low credit score you may find difficulty to obtain remortgage finance or there may be higher interest charges.
– Car finance and insurance
Many people fail to realise that common insurances such as car insurance are in effect credit agreements. You have agreed to make regular payments over a predetermined period of time to obtain a particular service. Therefore, insurance companies will carry out credit checks before agreeing to cover and may well demand higher rates of interest to offset the potential risk.
The same can be said for car finance – it might be hard to acquire approval while on DMP.
Internet/mobile phone contracts
It is only when you get into financial difficulties that you will realise the level of credit that many of us sign up to on a regular basis. Existing Internet/mobile phone contracts would likely still be honoured if you have not missed any payments. There is also a good chance you could sign up for a new, relatively cheap, Internet/mobile phone contract. However, if you are looking to sign up to an expensive Internet/mobile phone contract you may have problems.
There is a general misconception that credit difficulties for an individual will have an impact on others living in the same house. This is not the case. If there is a connection, such as a joint loan where payments have been missed, then both parties will see an impact on their credit scores. However, the idea that credit rating agencies issue a carte blanche default notice across the whole household is simply wrong.
Rebuilding your credit score
As soon as your DMP arrangement has been completed you can start to plan ahead and rebuild your credit score. All payment default notices will be removed from your credit file after six years even if the outstanding debt has not been repaid in full. Remember, there is no provision for debts to be written off at the end of a DMP arrangement. Upon the expiry of a DMP, in theory, your finances should be more organised and you would be obliged to fulfil the contractual payments on any outstanding debts. As you might expect, credit accounts relating to DMP debts would automatically be closed.
Either way, if there is outstanding debt at the end of your DMP you will still be expected to honour this.
Summary
Like so many debt management arrangements, the intricacies of a DMP can vary slightly between creditors. As this is an informal arrangement any party can terminate or pay off early the agreement at any time. However, if you have agreed revised payments via a DMP it is in your best interests to make timely repayments for the full term. All default notices on your credit records will be removed after six years. Upon expiry of your DMP you can then begin to rebuild your credit rating and look to the future.