Does Debt Consolidation Affect My Credit Score

How Does Debt Consolidation Affect My Credit Score?

Last updated: January 27,2021
Originally Published: July 09,2020
by Rosen Valchev

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How to take advantage of debt consolidation

Does debt consolidation affect my credit score positively or negatively? The short answer is – It depends. You should determine whether loan consolidation makes sense depending on your specific financial situation.

To give you the best idea of how to take advantage of debt consolidation let’s discuss a few crucial matters. First, when should you opt for debt consolidation. Second, how you can perform a debt consolidation. Last but not least, is debt consolidation going to hurt your credit score or help you to increase it.

When to perform debt consolidation?

Generally speaking, you should consider doing a debt consolidation if it will help you alleviate your financial struggles. Here are the two top reasons to do a loan consolidation:

Read More: When Should I Get a Personal Loan?

1. If you can’t keep track of all your credit accounts

Many people find it difficult to juggle multiple credit accounts. When you have several accounts with several lenders it can be extremely frustrating to track all payment amounts and due dates.

Often you can fail to meet the deadlines and incur a late fee. This also hurts your credit score. So if you find yourself in this situation you should take immediate measures.

Debt consolidation is a perfect solution in this case. You can get one loan from one lender, typically with a fixed monthly payment, and cover all other debts you have. This certainly can make your life easier. You have to track only one monthly payment and due date.

The best part is your credit score will increase for sure in the long haul. When you are making timely payments for the right amount, your behavior improves in the eyes of credit bureaus.

2. If you can get a better interest rate and lower the overall debt amount

When you have multiple credit accounts they typically have different interest rates and annual fees. If you can get a better interest rate on a new loan you should go ahead and do that. Why pay more when you can pay less? 

However, you should not consider the interest rate alone but also the repayment period. For example, let’s say you currently owe 10,000 which should be repaid in 3 years with 15%  fixed APR. That makes a total of 14,500 you should pay for the whole period.

Now, imagine you take out a debt consolidation loan for the same amount with 10% APR and 5 years repayment period. At first, it may seem like a bargain. But the total you will pay is 15,000 which is more than the amount you owe originally. 

Of course, your monthly installments will be smaller which is an advantage. So it is up to you to decide.
In most cases, credit cards have very high APRs. That is the reason many people consider consolidating their credit card debt with another loan.

It is an option but there is an alternative to that. You can combine all your current credit card debt into a new credit card with a balance transfer.

If the new credit card has a lower interest rate that is great. However, the best option is to get cards that offer 0% intro APR because these cards provide cardholders a specific time frame where they don’t have to pay for interest (usually between 12-24 months)

There are many lenders that waive the interest for a certain period of time as a credit card sign-up bonus.  You can check the best three 0% interest rate credit card offers for 2020 and see for yourself.

Image by TheDigitalWay from Pixabay

Choosing the right type of debt consolidation loan

There are different ways you can do debt consolidation. All of them have one thing in common. You get a single, new loan to cover all or most of your existing loans. Let’s take a look at the loan options you have to perform debt consolidation.

Personal Loan

Most individuals prefer this approach. Getting a personal loan with a lower interest rate to cover your credit card debt is often a great idea.

Nevertheless, make sure you don’t end up paying more than you should. Usually, personal loans have origination fees and high annual fees. That can eat up the difference in the interest rate you will save.

On the bright side, you will have only one payment to worry about. Banks offer personal loans and that is the first place most people go to seek one.

While banks can provide good rates they usually demand a great credit score and perform a hard credit check that can hurt your credit score even if you are not approved. That is why online lenders are a great alternative.

For example, with guidetolenders you can compare multiple lenders and choose the best one for your debt consolidation loan. The process is extremely smooth (as opposed to banks). You can get approved easily and your credit score remains untouched when you compare lenders.

Also, you can get your funds in 24 hours from approval which can’t happen with most high street banks.

Another important thing to consider before taking out your personal debt consolidation loan is the amount you qualify for.

If you can get more than your current debt amount, your best move is to use the excess amount to repay the loan faster. To make that work you should take out a personal loan that has no prepayment penalty

Balance transfer cards

We already mentioned you can get balance transfer cards to consolidate your debt. If you choose that option, makes sure you don’t get in the trap of overspending.

When you clear your credit card balance it is tempting to go back to your old spending habits. You should be cautious about that and act smart. If you play your cards right you can even increase your credit score.

Read More: How to Increase Credit Score to 800

Home equity loan

Unlike personal loans and balance transfer, this is a secured loan. If you stacked up ownership in your home you can use that as a collateral to get a lump sum and cover your debt.

However, be very mindful. If you can’t repay the loan you can lose your house. So don’t take an unnecessary risk if you are not 100% sure you can keep up with the payments.

Borrow money from your 401(k) plan

This is not a typical approach but you can also borrow money from your retirement savings with a 401(k) loan. Usually taking out a 401(k) loan isn’t the greatest idea.

Still, since the stock market is currently down this may be a very good opportunity to draw such a loan without losing value stacked up in your retirement account. It also doesn’t affect your credit score

Debt Settlement

In their effort to save money many people resort to debt settlement companies. These companies offer to settle your debt at a much lower rate than your original debt amount.

Many individuals think this is a good approach to lower their debt amount. Unfortunately, that is not true.

Ultimately you will hurt your credit score severely and risk being sued by the lender. That is why debt management is a much better alternative to debt settlement.

Does debt consolidation hurt your credit score?

Debt consolidation can affect your credit score both positively and negatively, depending on your behavior. In the short term when applying for a personal loan or a balance transfer card your credit score will slightly drop.

That is happening mainly for two reasons:

  • Lenders perform a hard credit inquiry to issue a balance transfer card or a personal loan.
  • You are closing old credit accounts that have history and simultaneously opening a new one. Credit institutions consider new credit accounts as riskier and that is why they lower your credit score.

However, in the long run, by improving your repayment behavior your credit score will bounce back and even increase. If you repay the full amount you ought to and you do it on time you are on the right track. 

Ensure you don’t return to old spending habits. Your credit cards cleared balance may trick you into spending more but don’t do that. Remember why you consolidated your debt in the first place.

On the opposite side, if you have a flawless credit history and behavior you should think carefully before consolidating your debt.

There is a high chance your credit score will drop significantly and remain there for a long period of time. That is because you are closing multiple credit accounts with great history and opening a new one.

Debt Consolidation Pros

  • Increases credit score over time
  • It can lower your interest rate
  • You can pay less than your original debt amount
  • You have only one payment and due date to worry about

Debt Conolidation Cons

  • Your credit score drops by a few points initially
  • After consolidating your debt, you may continue bad spending habits and end up in more debt

Consolidating your debt is in your hands

Now you know everything you need to decide whether debt consolidation would make sense for you. Don’t let doubt and fear distract you from handling your debt. Many lenders are currently more flexible because of the Coronavirus so now may be the best time to take action.

The first step is to check your options. You can head to website guidetolenders to do that or use another similar platform. Like smarter loans for example. The choice is yours. Your debt-free future is in your hands.

Responses are not provided or commissioned by the bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by the bank advertiser. It is not the bank advertiser’s responsibility to ensure all posts and/or questions are answered.

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