Does Debt Relief Cancel Credit Cards?

Looking into the impact of debt relief on credit cards? That’s a good sign. It means you're gathering facts before deciding on your next move.

How credit cards are handled while you’re enrolled in a debt relief program varies by the type of relief method you choose. For example, debt settlement is different from debt consolidation or counseling. 

Let's explore how debt relief impacts your ability to use credit cards, and how different debt relief methods operate. The goal is to help you determine if debt relief is right for you and, if so, which type would serve you best. 

Does Debt Relief Cancel Credit Cards?

The short answer is "sometimes." There are several effective debt relief methods, and the one you choose determines what you need to do with your credit cards. While having access to credit cards may be important, it's only one of several factors to consider as you decide which debt relief method best fits your financial situation and lifestyle. 

We’ll look at how different debt relief methods impact your ability to use a credit card.

Debt management plan (DMP)

Credit card accounts are typically closed for a DMP.

Most debt management plans are designed to be completed in three to five years, helping you pay down debt faster than you could have by only making the minimum monthly payments. 

When you enroll in a DMP, creditors significantly reduce or eliminate interest charges to your debt. As a show of good faith, they ask you to agree not to add any new debt while paying them back. They typically require the accounts to be closed to ensure the new, lower interest rates are used to pay down existing debt rather than for new purchases.

In some cases, you may be able to leave a credit card off the program to use for emergencies. Your emergency credit card must remain in good standing. 

If you’re married and your spouse has credit cards in their own name that aren’t enrolled in the program, they can continue to use those cards as usual.

Debt consolidation loan

You don’t have to close your credit card accounts for a debt consolidation loan, but sometimes it’s a good idea.

With a debt consolidation loan, you borrow enough money to pay off existing debt, then repay the new loan by making monthly payments. If you apply for a debt consolidation loan, the lender considers your debt-to-income (DTI) ratio. DTI measures your monthly debt payments against your total monthly income. Most lenders require a DTI of 41% or lower.

When you take out a debt consolidation loan, lenders commonly factor in the new loan payment and factor out credit cards (because they’re getting paid off). 

If overspending led to your debt, you might consider closing your credit card accounts after you pay them off with your new debt consolidation loan. If you end up putting new transactions on those cards, you could end up in even more debt.

Debt settlement 

Your accounts are typically closed when you choose debt settlement.

You may be able to continue using your credit cards following debt settlement, depending on your specific financial situation. To understand why there’s no black-and-white answer, it helps to know the ways debt settlement can impact you.

• Stopped payments. If you stop making payments to your creditors while you save enough money for settlement offers, your accounts could be closed, whether you want them to be or not. 

• Credit standing. Debt settlement could affect your credit standing. Your current creditors have the right to periodically review your credit reports and decide to lower the credit limits on cards not included in the settlement as a precaution or cancel them entirely.

• Creditor requirements. Debt settlement involves negotiating with your creditors to clear existing debt for less than the full amount you owe. The settlement agreement between you and your creditors typically requires you to close accounts. 

• A bad impression. Although you might technically be able to use credit cards not enrolled in your debt settlement program, doing so could create complications. For one, the creditors you're trying to negotiate with can get the impression that you have no intention of getting out of debt, weakening your negotiation position.

• Tougher to track. Let's say your debt is settled and you continue to make new charges on a credit card. You may complicate things for yourself by making it tough to stay on track with your program payments. 

Bankruptcy

Accounts are typically closed for bankruptcy.

The two most common types of bankruptcy are Chapter 7 (certain assets are sold to pay off your debts) and Chapter 13 (you make regular payments for three to five years). One of the first things you're asked to provide the court is a list of creditors, including credit card companies. You can’t exclude any accounts. Everyone you owe money to is notified that you've filed for bankruptcy. Nearly all credit card issuers cancel your account once they receive a notice. 

Should You Use Credit Cards After Debt Relief? 

Whether you can technically continue to use your credit cards after debt relief depends, in part, on the type of relief you opted for. 

If your credit cards are still open and you have the option of using them, the question becomes whether doing so is the best move. 

Why you may want to wait a bit before you use your credit cards

Waiting to reintroduce credit cards into your life has a number of advantages. For example:

• Clean slate. Now’s the time to rebuild financial confidence, and you can use all that you've learned during the debt relief process to create the future you want. Take several months to adjust to living without relying on credit. You might consider putting money you were paying into the debt relief program into a high-yield savings account until you've saved up six months' worth of expenses. 

• Build strong habits. Several months gives you time to become comfortable with budgeting. Money management becomes habitual. The more you live on a budget and save for a rainy day, the more natural it begins to feel. 

• Impress your creditors. Avoiding credit card use for a while allows you to carefully pay all other bills in full and on time. If you've ever missed a utility payment or been late on an auto loan, your creditors will definitely notice that you're turning things around.  

Credit cards as a tool in your arsenal

You have a choice. You can allow credit cards to entrap you or you can use them as one more financial tool in your arsenal. For example, by paying your credit card balance off in full each month before the due date, you get the use of the money without having to pay interest. As a bonus, you continue to build your credit score. 

What Happens to Your Credit After Debt Relief

Here's a look at typical outcomes:

• Debt settlement. Your credit score takes a hit when an account is reported as “settled” instead of “paid as agreed.” Most people settling debts have accounts in collections, and those can also cause significant credit score damage.

• Debt management plan. Your credit score takes a hit if you have to close credit accounts that still have a balance. If there’s a notation on your account that you’re enrolled in a DMP (and there usually is), creditors checking your credit history could assume you've had problems making payments. This could make it more challenging to get new credit.

• Consolidation loan. Applying for a new loan could cause your score to temporarily lose a few points. Paying off your credit cards with an installment loan could have a positive impact on your credit if doing so gives you a lower credit utilization ratio.

• Bankruptcy. Chapter 7 and Chapter 13 bankruptcy cause significant credit score damage for seven to 10 years.  

How to Rebuild Credit After Debt Relief

What goes down can also go up. The best part of getting through debt relief is knowing your finances are in better shape, you can afford your monthly bills, and you can work on rebuilding your credit. Here are some ways to make that happen:

• Pay your bills on time every time.

• Keep an eye on your credit reports to ensure no mistakes are listed and no new accounts are opened in your name without your knowledge.

• Keep your credit card balances as close to zero as possible. If one sneaks up, focus on bringing it down.

• Get started on a new, healthier credit score by opening a secured credit card that reports to the credit bureaus. You’ll need to pay a cash deposit.

• Become an authorized user on a friend’s or family member’s account. 

• Don’t apply for credit until you really need to.

Enjoy Your Debt-Free Life 

Credit card debt isn’t the end of the world, but it's probably not something you want to go through again. It’s possible to transition away from credit card dependence, even if you've been using cards to pay expenses for years. 

You want to be ready for whatever curveballs life throws at you, whether it’s a car repair or you need a new dishwasher. Here are a couple of strategies to try on for your new financial life:

• Set some aside. One of the best ways to avoid pulling out a credit card to pay for a car repair or a new dishwasher is to set a bit aside ahead of time. It doesn't have to be much. Throw your change into a bowl at the end of each day and deposit it into an account once a month. Have a garage sale to get rid of the stuff you no longer need and use the money to plump your growing emergency fund. You might be surprised how quickly small deposits add up and how useful it is to have that money available when it's needed.

• Track it all. Use a free budgeting or spending tracker to monitor cash flow, identify areas that could use an adjustment, and celebrate how much money you're saving. Some trackers are available as websites and mobile apps, making it easy to track wherever you are. 

Most of all, give yourself a break. Because you're human, you’re not supposed to be perfect—and that's perfectly wonderful. The best part of growing older is realizing there's something to be learned in every situation you face. 

Making the Right Choice for Your Financial Situation

Once you've compared different types of debt relief, choose a plan you fully understand, and one you are confident you can stick with. If you need someone to help you sort out your debt relief options, Freedom Debt Relief can help.