Debt consolidation is taking all debt and combining it into one payment. Some do this by taking out a debt consolidation or home equity loan and paying all of their creditors off while making the one loan payment. Others use a debt consolidation service that collects one monthly payment from you and pays all of your creditors on your behalf. Some go to work to negotiate reduced balances, lower interest rates or a reduction or suspension on fees. The ultimate effect on your FICO credit score depends on the method you choose and how you use your credit afterward.
History
Debt consolidation and home equity loans were popular from the late 1990s to the late 2000s. These loans are a form of shell game with debt. The amount of debt stays about the same, but it isn't to as many creditors. Since the fundamentals of the borrower's debt picture does not change, their FICO score is not affected a great deal. Many times the monthly payments goes down only because the repayment period is stretched out for a longer time, like paying a five- year car loan off with a 15-year home equity loan.
Behavior
How borrowers handle their new-found "financial freedom" was the bigger impact on how the consolidation affects their score. Many borrowers go out and max out the cards they just paid off. Others close accounts, which reduces their amount of available credit and raised the percentage of credit used vs. what is available. The closing of long-standing accounts did further damage by shortening the borrower's credit history. All of these make them a greater credit risk and lowers the FICO score. Disciplined borrowers use the reduced monthly payments they get to pay down their debt faster and keep accounts. Their scores go up.
Considerations
To determine if a loan for debt consolidation is the right way for you to go, sit down and look at your total interest charges, fees and principal payments you make over the course of a year and measure them with how much the payments and fees on your debt consolidation loan are for a year. In addition, compare what the cost will be by the end of the payment terms. You must also decide if you have the discipline to not spend yourself back to the same place without closing all of your accounts.
Debt Consolidation Services
Debt consolidation services are the better choice for people who are not good with fiscal restraint or who do not have the ability to get a debt consolidation or home equity loan with good terms. By guaranteeing your payments are made on time and negotiating lower interest rates or fees, your score will eventually benefit. They may also be able to find ways to help you pay down your debt faster and manage your money better, so that your score will continue to improve.
Negotiation Services
Debt consolidation companies who negotiate lower payments by getting creditors to agree to a lower balance help and hurt your FICO score. Your score will take a hit in the short-term because your creditors will report that they are settling for less than what you owe, which means that you have not fulfilled your financial obligations and are a risky credit bet. However, since the lower payments may allow you to pay your debt off faster or stay current, your score will end up better than if you hadn't used the service.
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