How does a DMP or a payment arrangement affect your credit rating?

A debt management plan (DMP) is a good debt solution for many people. If you are trying to decide whether you need one, you may want to know how bad the effect will be on your credit file, and how long it will be before your credit rating recovers. There isn’t a simple answer however:

• DMPs are used in a lot of different situations;
• because they are “informal” arrangements creditors don’t all have to respond in the same way;
• each future lender does their own credit assessment and these may give different weights to parts of your credit history.

This article looks at what may be recorded on your credit file in a DMP, how lenders tend to view these and some scenarios so you can see which bits are likely to matter most for you. At the end I look at whether any of the alternatives to a DMP might be better for your credit rating.

It also applies to payment arrangments, which have the same effect on your credit record as a DMP.

How important is your credit rating?

On one level, not very! If you need a DMP, you can’t manage the normal debt repayments and there is no debt solution that will let you pay less and keep a good credit record.

Finding the right debt option for you and your family so you can clear your debts is the key to your financial future. Your credit rating is only a very small piece of this bigger picture. So don’t let worries about your credit rating stop you from making the right debt decision.

How missed payments affect your credit record

You may think if you miss a loan payment or pay less than the minimum on your credit card this is a “default”, but this is not how it is described on your credit report at the start.

Six years of payments are shown on your credit record, with the most recent first. When you first miss a payment, the current month’s payment is marked as being one month late. Then if you miss the next month, the first month is shown as being two months late and the recent month is shown as being one month late.

A Default is a special marker that your creditor adds to your debt record. It is usually added when the account is between 3 and 6 months in arrears.

What difference does a DMP make?

In a DMP you offer a reduced payment to each creditor and ask them to freeze interest and charges. Creditors do not have to accept this offer – they are more likely to do so if you say why you have financial problems and send them details of your Income & Expenditure to show you can’t afford the usual payments. If you are using a DMP firm, the firm will send these details to the creditors.

A creditor often accepts a DMP offer, to be reviewed after six months or a year.  Here, even though your creditor has accepted your offer, it is expected that the debt will revert back to the original terms at some point. Arrears are calculated against the original terms however, so your credit record will continue to show that you are getting behind with the agreement, even if you are making these agreed lower payments. It will also show that an Arrangement to Pay (AP) is in place.

If you keep up with the agreed reduced payments your account may not be defaulted, but if you miss a payment or if the arrears get to be large it may be. So you can get a default if you are more than 3 months in arrears compared to what your original payments were, but some lenders will just carry on with AP markers.

Defaults fall off after 6 years

A debt marked as Defaulted will drop off your credit history six years after the date of the Default. It doesn’t matter if you have repaid the debt, are still paying it or have stopped making any payments, the debt will still disappear.

After a defaulted debt falls off,  it will never come back. However it still exists, see Must I pay a debt that’s not on my credit file? for details.

How do future lenders view DMPs?

It’s hard to generalise as each lender has their own method of credit scoring, but most people would agree with the following:

• creditors don’t like Defaults. They would prefer to see an Arrangement to Pay (AP) in your history rather than a Default. This post on a MoneySavingExpert forum has detailed examples that show one person’s experience of the ways different creditors and different credit reference agencies report and react to APs.
• creditors care more about recent events. Anything which has happened in the last year or two is much more important than four or five years ago. Whatever is wrong with your credit history, time is a great healer.
• the amount of debt you have is also important – if you owe too much you won’t get offered more debt even with a great credit record! So a DMP that helps you pay down your debt is in the long-term going to be a good thing.

Some DMP scenarios

Those generalisations may not seem much help to you. So let’s look at some possible scenarios:

(A)  temporary DMP with a Default
Perhaps you were without any income for a year because of redundancy or sickness. During this time you set up a DMP making token payments but at least one of your creditors Defaulted your account. At the end of the DMP you go back to making the usual payments. Here your credit rating will start to improve, but the Default is going to put a lot of creditors off. You can add a note to your credit file explaining the cause of the default, but you may struggle to get a mortgage at a good rate until the default has dropped off after 6 years.

(B) DMP completed after four years
This could occur if you were making significant payments to your debts, but not the full amount. Your creditors accepted your offer, froze interest and didn’t Default your accounts. After 4 years, your debts will be marked as Settled and from here your credit report starts to improve but the payments history will still show the DMP for 6 years from when it was completed.

You probably aren’t going to get a mortgage offer for two or three years, but after that it should be fine (assuming of course that you have a good deposit and pass the affordability checks for what you want to borrow). Even if you have defaults on your credit record, if the default date is over 3 years ago and the debt is now repaid, you will probably be able to get a mortgage.

(C) Eight years into a DMP, four still to go
Sometimes DMPs can drag on for ages – at the start you were making reasonable payments, but had to reduce these when your pay was frozen for a few years and your bills kept going up, then your child tax credits were cut etc. Many of your debts were probably marked as Defaulted and already they will have dropped off, but if some weren’t they will show until the end of your DMP when the debts are settled and then for six years afterwards. However, you may be able to improve this by asking your creditors to add back-dated defaults, see What should the default date for a debt be? for details about how to do this.

DMP alternatives and credit reports

Would any of the alternatives to a DMP have been better from the credit rating point of view?  Debt Relief Orders, IVAs and Bankruptcy are forms of insolvency and all have the same effect on your credit rating: a notice is placed on your credit record and all debts that haven’t previously defaulted will have a default date of the start of your insolvency, dropping off after six years.  After the defaults have dropped off, most people who have chosen one of these three options then struggle to rebuild their credit record for several years, often finding it difficult to open bank accounts and having to get bad-credit cards such as Vanquis to try to rebuild a good credit rating.

Going for one of these insolvency options would not have been a sensible alternative to the temporary DMP in scenario (A). One of three would almost certainly have been better than the long DMP in scenario (C), although here the credit rating problem is just a minor side-effect of being stuck with unmanageable debt for far too long.

The interesting case is (B)  where the DMP lasted 4 years but the footprint remains on the credit file for a further 6 years – is this ageing trace of a DMP more or less damaging than having gone insolvent? I think most people would say that the DMP is preferable from the credit rating point of view.

The other possible alternative to a DMP is selling assets, usually a house with equity. From the credit record point of view, this leaves you with a great rating!  If you do have assets and are looking at a lengthy DMP, it may be better to take the tough decision to sell the house.

What about getting a mortgage?

Your credit record matters when you are applying for a mortgage, but so does having debts – see Can I get a mortgage in a DMP? for more details.

Conclusion

If your DMP is going to be temporary and you expect to be able to start making the usual monthly payments to your debts, or if you will be able to clear all your debts in a DMP within a reasonable number of years, then you shouldn’t worry about the effect the DMP has on your credit rating – it won’t be great but there aren’t any better alternatives.

If your DMP is going to be very prolonged, then you should probably be looking at the alternatives. Not only will they let your credit file recover more quickly, but they will give greater certainty over the process.