How Will Debt Consolidation Affect My Credit Rating?
Debt consolidation is a way to simplify the process of repaying debts and repairing a credit rating, but it has drawbacks.
If you are in over your head in debt, consolidating all of your accounts and balances so you can make a single monthly payment gives you a chance to get back on top of your budget. It stops the clock on collection efforts and stops interest from accruing across several accounts, so you won't get any surprises when it comes time to pay up. As attractive as the notion of debt consolidation may sound, it does have some downsides. Debt consolidation will impact your credit score, but whether it is positive or negative depends on your management of the consolidation.
Debt consolidation is often marketed as rolling up all of your debts into a single account, but in reality, it involves paying off your outstanding accounts while taking on a new debt. When you consolidate your debt, you get a new line of credit, usually through a home equity loan, personal loan or credit card. You use the money from that new line of credit to pay off your credit cards and other debts you have. After you have paid off those bills, you are left with the single payment on the new line of credit you used to satisfy your other debts.
Dealing with a single payment is much easier than managing several accounts. Interest and fees are only adding up on one account instead of several. Because of this fact, you always know exactly what your monthly payment will be, so you can budget your money more efficiently.
Likewise, debt consolidation can save you money. Home equity loans and personal loans have a much lower interest rate than most credit cards. Sometimes, a credit card with a zero percent interest rate is also used for debt consolidation. If you have thousands of dollars of debt at a high rate of interest, reducing that interest could save you 20 percent or even more on your debt.
Debt consolidation only works if you manage it correctly, but even doing the right thing with your debt consolidation payments can damage your credit score temporarily. An important part of your credit score is the amount of credit you have available to you and what percentage of that credit you are using. If you close your accounts after you pay off your debts, you will reduce the amount of credit you have, thus lowering your score.
If you leave the accounts open, however, you may be tempted to use them again. You could end up with paying your debt consolidation loan payments plus charging up all of your cards again.
Debt Consolidation Loan Company Dangers
If you do not qualify for a home equity loan, personal loan or zero percent interest credit card, a debt consolidation loan company may be able to help you. Be aware, however, that loans from these companies have higher rates of interest than other kinds of loans. If you have less than perfect credit, the loans they offer may not be much of an improvement from the debt you have.
Also, never allow these companies to negotiate lower payoff amounts for you with your creditors unless you have no other option. This will go on your credit as a debt settlement, which is almost as damaging as a bankruptcy. Before you sign up with a debt consolidation company, check it out with the Better Business Bureau.
Credit Score Protection
If your accounts are in default, then paying off your accounts can improve your score. That benefit can easily be squandered if you don't manage your consolidation properly. Consider seeking personalized advice on better managing your credit and whether or not you should close your paid off accounts from a non-profit credit counseling service or your bank. This short-term fix for getting out of debt only helps your credit score if you avoid getting back in over your head.