Debt consolidation is a common way for many consumers to lower the impact of monthly bills, yet many people are concerned about the effect such consolidation will have on their credit score. While there are legitimate questions and some negative effects, consolidating debt can also have a positive impact on your score. Before beginning on a debt consolidation program, you'll need to understand the implications.
Paying Off Credit
One of the best effects from debt consolidation is that, to lenders, your accounts will appear paid-off. Even though you have simply moved your existing credit into a new credit account, your credit score can be impacted in a positive way. A new credit account could come in the form of a home equity loan or line of credit or from a credit counseling firm. If you decide to consolidate your debt through a service, that activity will be noted on your credit report. Many consumers worry about having the use of a counseling service recorded on their credit report but, according to the Fair Isaac Corporation, even if you use a credit counseling service and it is reported, "you should not have any impact on your FICO score." More importantly, though, if you pay off your new credit quickly and make payments consistently and on time, that will have an even better impact on your score.
Paying On Time
A very important aspect of debt consolidation is what you do after you have made your decision. If you have consolidated with a home equity loan, for example, you'll need to make payments on the new account on time and any way you can accelerate your payment will be a benefit. Conversely, if you are consistently late on payments, your score will suffer. If you have decided to use a credit counselor to manage your debt, you'll need to make sure your payments are being paid on time and in full by the firm or person you have hired. If your counselor is delinquent on payments, your score will suffer.
Using Debt Settlement Programs
Consumers are often temped by debt settlement programs that offer to cut your bills significantly. Those enrolled in debt settlement deals do see a decrease in their bills but what they have done is defaulted on their debt. Once you have defaulted, your credit score will be negatively impacted and it will take a long course of good credit history to lift your score. If you default, you might also find yourself having difficulty getting new credit. According to Bankrate.com, if you are enrolled in a debt settlement or debt management program, you might find credit card companies shying away from you, seeing you as a risk for payment of future credit you might accumulate.
Closing Out Credit Card Accounts
When consolidating debt, the temptation is to close out the cards that got you into trouble in the first place. However, closing out these cards after you have consolidated may impact your score negatively. If you are planning to cut up your credit cards, choose the newest cards first. Your oldest accounts will provide you with the longest credit history and, hopefully, that history will be mainly good. You'll also want to avoid transferring balances from one credit card to another to take advantage of introductory or promotional rates. Changing credit cards every six months or less also raises red flags. It's best to pay off your cards on a regular schedule and only close out debts after you have paid off debt so you don't give the appearance of maxing out your credit.
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