Debt consolidation programs can seem like a great deal at first. The prospect of bunching up all your loan payments into a single payment, plus paying less each month, make these deals seem too good to believe. Unfortunately, they often are. In the long run, debt consolidation can be more harmful than helpful, and can end up damaging your credit score.
Credit Score Factors
A credit score is a number that represents your potential risk as a borrower. The higher the score, the less risk you represent to a lender; the lower the score, the more risk you pose. Companies that create credit scores use the information in your credit report to come up with the number. Though the exact formulas are trade secrets, your score is based on five key factors: Your payment history, the amount you owe to lenders, how long you've had credit, how many new lines of credit you have and the mix of credit types you use.
Impact of New Loans
When you consolidate debt, you take out a new loan to pay off all the old loans. You are then responsible for paying back the new loan. Like all loans, the debt consolidation loan influences your credit score. In the beginning, even applying for a new loan gets reported and appears on your credit score. This inquiry can slightly lower your score, though this doesn't last long.
Consolidation Payments
If you consolidate your loans and start paying back the debt, you credit score will probably go up. As long as you make regular payments and don't fall behind, your credit score will reflect this positively. However, debt consolidation loans typically allow you to pay less every month by increasing the amount of time it takes to pay back the loan. This ends up requiring you to make more payments, and thus gives you more chances to miss a payment and lower your score.
Long Term Effects
People who use debt consolidation loans can face difficulties even if they end up paying less money per month to pay the debt. Using a loan to pay off a loan doesn't do a lot to change the lender's behavior, and if the borrower is unable to pay back the new loan, the problem of endless borrowing continues. This in turn lends to lower credit scores, because the borrower is unable to minimize his debt and often fails to make timely payments.
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