If you are considering debt consolidation, chances are you are already deeply in debt and your credit score may be suffering. If this is the case, using a debt consolidation generally company won't make it any worse, though there are exceptions. If credit score is a concern to you, then it is best to carefully review each program to see how payments are managed and reported to credit bureaus.
The Debt Consolidation Process
Debt consolidation begins with an interview between a credit counselor and the client. The counselor reviews the client's expenses versus income to develop a debt reducing strategy. Trustworthy companies let clients know if consolidation is a valid option or if simple spending adjustments or bankruptcy are better choices. Counselors offer plans that consolidate high interest credit card payments into one affordable lump sum. The counselors then work with the client's creditors to negotiate lower interest rates. A percentage of the monthly payment goes to the debt consolidation company as payment for these services.
Benefits
Working with debt consolidation companies means that creditors recover most of the outstanding debt. Clients undergoing debt consolidation no longer receive harassing collection calls or late fees. Debt consolidation improves credit rating because the payments are made on time and kept current. This is important since late payments have a negative effect on credit scores. Working with a debt counselor also helps clients understand budgeting and money management.
Disadvantages of Using Debt Consolidators
Many debt consolidation companies are reputable, however, those that are not may cause damage to your credit score. Such companies have been reported to take payments from consumers without sending them to creditors. Some have made late payments to creditors on their clients' behalf. A few offer debt consolidation loans that have high interest rates, meaning the consumer will have a lower payment but end up paying more over time.
Effects
A statement on the credit report indicating a modified or reduced balance after a debt consolidation is viewed negatively by creditors. Sometimes an agency closes the credit card accounts when a client starts the program. This is detrimental because the overall available credit decreases but the balance stays the same. It is better to pay off the accounts first and then close them. Closing older accounts is not recommended because they have a longer credit history, and payment history accounts for 35% of a credit score.
Consolidating Credit Card Balances
It is tempting to transfer balances from high interest credit cards to those with low introductory rates. This helps reduce debt in the short term if you are diligent about paying down the debt. Looking for deals that have a long introductory period will give you more time to pay down balances. Remember to close the accounts yourself because accounts closed by the creditor will reduce the overall credit score. Another danger to using balance transfers is that opening accounts repeatedly reflects badly on your credit report.
Other Options
Non-profit credit counselors work with consumers to provide debt management advice without financial obligations. They help analyze spending habits and can assist in setting up budgets. Counselors can help consumers negotiate better terms with creditors. This usually has no impact to the credit report and can be done without debt consolidation. If debt is not extreme, paying higher minimum payments could help pay down debt faster than using a debt consolidation agency.
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