How a hardship plan can affect your credit

Smiling woman relaxes after using a hardship plan to dig herself out of debt.Image: Smiling woman relaxes after using a hardship plan to dig herself out of debt.

In a Nutshell

If you’re overwhelmed by credit card debt, your card issuer’s hardship plan could give you the breathing room you need to dig out and get back on the road to great credit.
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Are you trapped in a debt spiral of mounting credit card debt, high interest rates and a minimum monthly payment that’s becoming difficult to meet?

If you are, you might be feeling frightened or overwhelmed. But your credit card company likely offers an unadvertised program that could make all the difference.

A hardship plan, also known as a credit card payment plan, is a well-kept secret that has the potential to save you big bucks in interest, reduce your monthly financial burden and finally let you break free of your debt spiral.

Think a payment plan might be right for your financial situation? Let’s dive in to what a hardship plan is (and isn’t) and how it might impact your credit in unexpected ways.

What is a hardship plan?

A hardship plan is not the same as the debt management plans you see advertised on TV.

With a debt management plan, you work with a credit counselor who acts as the liaison between you and all your unsecured debt creditors. Typically for a fee, the counseling agency analyzes your income and spending, negotiates debt repayment terms with each of your lenders and pays all of them with a single monthly payment it collects from you.

With a hardship plan, however, there’s no intermediary and no mass payment of lenders. Instead, you work directly with your credit card issuer and participate in its unique repayment program. Many creditors do offer hardship plans, though you’ll rarely find them advertised.

“Each creditor’s policy is a little bit different,” says Thomas Nitzsche, credit educator and communications lead at Clearpoint, a nonprofit credit counseling agency. He notes that plans typically offer a combination of the following benefits:

When you’re facing a temporary financial rough patch — a recent job loss, medical emergency or serious accident, for example — Nitzsche says that calling your creditor and telling your story may persuade the company to offer you the money-saving perks of a payment plan.

Possible downsides of a hardship plan

The act itself of signing up for a hardship plan has no effect on your credit. However, once you enroll, your credit scores could be indirectly affected because of the way the program works.

First, your credit card issuer may put a note on your credit reports regarding your participation in its hardship plan. So while the note signals that you’re taking positive steps to responsibly repay your lenders, it could make potential creditors nervous about your financial situation. Before you sign up for a payment plan, talk with your issuer about what note (if any) will be sent to the credit bureaus.

Second, while you’re participating in a hardship program, your card company may close or suspend your account until your payment schedule is complete. And closing a credit card — whether you do it yourself or your card company does it for you — can hurt your credit scores by affecting a few different things:

  • Credit utilization ratio: Your credit utilization ratio represents the portion of your available credit that you actually use, and it accounts for a whopping 30 percent of your FICO® score. In general, your scores can increase as you use less of your total credit limit. So, when you shut down a card, you eliminate some of that available credit. And if you don’t decrease your credit card spending, your scores will drop to reflect the increase in your utilization ratio.
  • Length of credit history: Your credit scores reward you for having mature lines of credit. In fact, 15 percent of your FICO® score depends upon the length of your credit history. So if your creditor closes one of your older cards when putting you on a payment plan, your average credit age will decrease, and your scores could go down as a result.
  • Credit mix: FICO® rewards you for having a desirable combination of credit cards, mortgages, car payments and other types of loans. This combination — or credit mix — makes up about 10 percent of your FICO® score. When you close a card, your credit mixture changes, and that could affect your scores.

That said, participating in a hardship plan could actually benefit your credit scores in the long run.

How could your credit improve?

After you sign up for a hardship plan, you might see a concerning dip in your credit scores. This typically isn’t permanent, though it could take months of on-time payments and responsible behavior to get your credit back to where you’d like it.

If you successfully complete your program, that initial dip could transform into a sizable credit score increase. Here’s why:

If you’re thinking about signing up for a hardship program, you may have already missed some minimum payments on one or more of your cards. Payment history is the No. 1 factor in determining your FICO® score, making up 35 percent of the score. So you may have already seen your credit scores decline after missing payments.

Fortunately, sticking to a hardship plan’s payment schedule is an excellent way to rebuild your history of timely debt repayment. Your lender, who reported those late payments to the credit bureaus, will now report your consistent, on-time payments — which can mean good news for your scores.

Bottom line

So, is a hardship plan right for you?

They’re not right for everybody, Nitzsche says.

“If you’re somebody who struggles with being organized, if you have multiple creditors, if you’re intimidated by contacting all of them directly, or if the thought of managing all those individual payments each month is daunting,” he says, “it might behoove you to see a credit counselor and consider debt management.”

Just be aware that dealing with debt settlement companies can be risky, according to the Consumer Financial Protection Bureau, and might leave you deeper in debt than when you started. The CFPB recommends seeking out a nonprofit consumer credit counseling service as an alternative or speaking with a bankruptcy attorney if you’re considering that route.

If, however, you’re facing a temporary financial crisis or a relatively minor problem with just a few cards, your card issuer may be willing to extend concessions when it comes to repaying. So pick up the phone, call up your creditor and make your case. It could be the turning point in conquering your credit card debt.

About the author: Megan Nye is a personal finance writer with a decade of experience in the insurance industry. Her writing has been published by Business Insider, Citi, LendingTree and others. Megan has a bachelor’s in mathematics fro… Read more.