If you're considering consolidation for your debt, you have several options, including consolidation loans, debt management plans and balance transfers. The way you use these tactics is what will have the most impact on your FICO score. Those who are responsible and committed to paying off their debt and keeping it off will see a positive impact on their scores. On the other hand, those who continue to contribute to their debt will spiral further into financial despair.
Consolidation Loans
When you use a consolidation loan, you have to submit an application, which allows the lender to make an inquiry into your credit report. Inquiries create a minor negative effect on your credit score; however, if you use the loan to pay off your debt and keep it paid off, the positive effects far outweigh the inquiry. A consolidation loan wipes out your previous balances, which leaves you with newly freed credit. Many people fall prey to contributing further to their debt, which is bad news for your credit score.
Debt Management Plans
To qualify for a debt management plan, you must already be delinquent on your accounts, which means that your credit score has likely already taken a hit. An inquiry decreases your score even further. A credit counselor must recommend that you sign up for a DMP, and you make one lump payment to the counseling company rather than your cards. If the counseling company doesn't pay your creditors on time, this delinquency may cause your score to sink further. You should check to see if your credit counselor is listed with the Association of Independent Consumer Credit Counseling Agencies or the National Foundation of Credit Counseling before making any agreements.
Balance Transfers
Consolidating your accounts by transferring your credit card balances to cards with lower interest rates may damage your credit in several ways. First, opening a new account knocks about five points off your credit score immediately. Also, your FICO score heavily weighs your debt-to-credit ratio, so if your transfers bring the new card near its limit, it will also negatively impact your score. If you continually open new accounts and make balance transfers, this also reflects badly on your credit report and drags down your credit score.
Considerations
Aside from the effects on your FICO score, these consolidation options may also make it difficult to obtain new credit. Debt management plans, in particular, are seen as a mark on your credit report because credit counselors usually negotiate lower balances for DMP users, meaning that you're not paying back all that you owe. Also, many DMPs prohibit you from opening any new credit while on the plan. Consolidation loans are also seen as negative information and may make it difficult to borrow. If you have a history of jumping from one card to another, creditors may be leery of taking you on as a client. It's important to take these factors into consideration when deciding whether or not to consolidate.
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