If you’re struggling to pay bills or you want to eliminate the debt quicker, then debt consolidation might be a solution. However, before proceeding using this method of debt relief it’s crucial to understand the impact it has on your credit score, how it works, as well as the alternatives.
Here’s a review of the way debt consolidation functions ConsolidationNow: debt help
What is Debt Consolidation?
Debt consolidation is a type of debt relief that usually involves the taking out of a new loan to pay back previous loans, and then consolidating the debts them into one monthly payment. Consolidation of debt can provide a variety of benefits, like lower interest rates and reducing your monthly payment and removing the debt faster.
If you’re trying decide whether consolidating debt is the right choice begin by taking a look at your financial situation in general. It could be an option for you if you’re having trouble paying your bills, aren’t happy with the current amount of debt or not satisfied with the interest rates ( APRs) for your current loan or credit card.
But, it’s also crucial to know how debt consolidation can result in modifications to your credit rating. Be aware of how you can control your credit score when paying off the debt.
How Debt Consolidation Impacts Your Credit
Consolidation of debt can affect your credit score positive or negative. Here are five ways that debt consolidation may affect your credit score positively or negatively.
1. It could result in hard inquiries regarding your Credit
Each time you make an application to borrow money, the lender conducts a hard inquiry, often referred to in the process of pulling your credit to determine your creditworthiness. Every hard inquiry typically lowers your score on credit by couple of points. If you’re looking at different banks and applying for loans for debt consolidation with multiple banks simultaneously your credit score may be affected temporarily. Luckily, a lot of hard inquiries made within a predetermined periodof time, which can range between 14 and 45 days, are usually added together in the process of having your credit score determined.
Be aware that a hard inquiry isn’t required every time you contact the lender or visit websites. It is possible to conduct your own research and qualify for a loan, without having be able to complete the difficult inquiry procedure. A lot of lenders allow you to search for rates and get prequalified online with a gentle credit check, also called a soft pull, which will not affect your credit score. This lets you begin the process to find out if you’re eligible for a loan without damaging your credit.
Before you make a decision to go forward with a lender, make sure you read the small print and ensure that you are aware of whether you’re ready for your credit score to be verified with a formal inquiry in the course of your loan application procedure.
2. Your Credit Utilization May Change
Credit rating agencies and creditors take note of your ratio of credit utilization, which can make approximately 30 percent from your FICO credit score. The credit utilization ratio represents the amount of credit that you’re able to use at any given time. As an example, if are using a credit card with an amount of credit that is $15,000 with a balance of $4500 the credit utilization ratio will be 30 percent.
If your ratio of credit utilization increases following consolidation of debt, it may adversely affect your credit score. In the above example when you transfer the amount of $4,500 on your existing credit card that has the limit of $15,000 to another credit card that has an amount of credit that is $7,500 the credit utilization ratio for that newly acquired card is 60%, possibly damaging the credit rating.
However If you consolidate several credit card debts in one personal loan the ratio of your credit utilization and credit score may increase. Personal loans and credit cards are considered to be two different kinds of debt when it comes to assessing your credit mix. This accounts for 10 percent of your FICO credit score.
For instance, let’s say that you own three credit cards. Again, taking the previous example:
- The first card is a $4,500 balance, with a credit limit.
- The second card is an outstanding balance of $2,000 and an amount of $10,000 in credit.
- The third card is an account with a balance of $5,000 and the credit limit of $10,000.
Credit usage ratios that are 30 percent 20 %, 30 percent, and 50% depending on the three cards. (Combining the three cards your total credit utilization would be around 33 percent.) If you consolidate all three of these debts into a new personal loan amounting to $11,500, your ratio of credit utilization for the three cards will decrease to zero (provided that you keep the credit accounts open and aren’t spending more on the credit cards) This may improve your credit score.
3. It is possible that the average age of your accounts could decline
Another element that affects how credit-worthy you are is age of your accounts or the time that you’ve been able to open those accounts. This indicates your total duration of credit history. It accounts for around 15 percent in the FICO credit score.
If you establish an account with a credit card in the course of your debt consolidation program such as a new Balance Transfer credit card, or a credit card for personal use, your age of the accounts will decrease and you may notice an increase on your score. However, based on the number of other credit accounts you’ve got and the overall credit history of your it is possible that the drop won’t be that significant.
4. It may improve your Payment The History Over Time
The history of your payments is about 35 percent the credit rating. If you have a good history of timely payments, then debt consolidation might be a good idea to keep this part in your score. If however, consolidating your loans into a new loan with a lower interest rate makes it easier for you to pay punctually the debt consolidation process may aid in improve your credit score in the long term.
5. It might tempt you to close your accounts
If you’re in the process of debt consolidation It may be a good feeling to close the old accounts following an account balance transfer or obtaining an additional loan. Be cautious. Closing your credit card can reduce the average age of your accounts, or increase the ratio of your credit utilization. Both of these steps could affect your credit score.
Once you’ve completed the debt consolidation process you might want to consider closing the credit accounts you used to have open, but with no balances. Maintaining those accounts open appearing on the credit report can be good for your credit score in the event that you’re not in a rush to make use of them in order to accrue additional debt.
Strategies to Consolidate Credit
There are a variety of ways of consolidating debt
- Loans for debt consolidation. Debt consolidation loans are a form of personal loan offered by banks or credit unions as well as online lenders. When you take out this kind of loan could make payments directly to your debt or offer cash to the person who is borrowing to pay off the outstanding balances.
- personal loans. With a personal loan for debt consolidation it is when you get the loan through an institution like a credit union, bank and/or another institution in order to repay more-interest debts, including credit card debts and other charges.
- Credit card for balance transfer. If you have sufficient credit, you may transfer the balance of multiple credit cards onto a new Balance transfer credit card for an interest rate that is lower often at 0% APR during the duration of an introductory period.
- The Home Equity Loan. If you own your home and have accrued enough equity to be eligible to be eligible, you could be eligible for an equity loan for your home (HELOC) or home equity loan (HELOC) in order to pay off your debts with a lower interest.
- Refinance of a cash-out mortgage. A cash-out mortgage refinance allows you for refinancing the home at more than the balance outstanding. The difference can be used by cash in order to settle your outstanding debts.
Options for Debt Consolidation Alternatives
If you’re not ready to get another loan, or use a credit card, or tap into your home equity to pay off debt, there are a variety of other options:
- Pay off your debts by yourself. If your debt is manageable, you can devise a plan to pay off debt more quickly. If you earn enough and space in your budget for monthly expenses you might be able to pay off your debts quickly without consolidation by using the debt snowball method or debt avalanche technique.
- Sign up for a debt management plan (DMP). If you’re having difficulty paying your bills, collaborate with a non-profit consumer credit counseling company to create an arrangement for debt management where you are required to take care of your financial obligations by making one payment per month for the credit counseling company and then pay your creditors on your behalf.
- Filing in bankruptcy. If you’re struggling to make ends meet but you don’t wish (or not be able to qualify) to take out any additional money , and you aren’t sure that you’ll be able pay off your debts, you might want to think about filing for bankruptcy. The legal process could eliminate any or all your debts and allow you to make a fresh beginning. However, be aware that bankruptcy will remain permanently on the credit report for seven to 10 years.
- You should think about debt settlement but only as the last option. If you have been in debt for a while it is possible to negotiate with your creditors in order to settle an amount that is less that you are owed. This is known as debt settlement. You could do it by yourself or through an agency for debt settlement. Be cautious. Settlement of debts can be risky. Creditors aren’t required to accept your debt settlement proposal and might not be willing to discuss the matter. The process of settling debt generally results in some negative effects to your credit score. It is best to consider it as an option last resort.