How Will Debt Consolidation Affect Credit?

How Will Debt Consolidation Affect Credit

The average American has $8,000 or more in debt. If you're one of these consumers, you may consider debt consolidation as a way to reduce your monthly payment. Typically, these types of programs involve transferring your existing debt to a low-interest rate credit card or taking out a loan of some sort. Some banks may also allow you to use a home equity line of credit toward debt consolidation. The lure of low interest rates and one flat monthly bill often attracts consumers; however, debt consolidation is not without risks.

The Facts About Debt Consolidation

First and foremost, debt consolidation does not reduce the amount of debt that you owe. Though it may appear otherwise, taking out a debt consolidation loan gives you the same amount of debt that you already had. Although your interest rate may be lower, which may then reduce the amount of your monthly payment, the bottom line is you're still in debt: if you take out a $10,000 loan to pay off $10,000 in credit card bills, you are still $10,000 in debt. Unfortunately, many consumers forget this fact. Instead, they see a zero balance on their credit cards and think all is well. This is where debt consolidation can become dangerous.

Things to Consider

According to financial analysts, most consumers who utilize loans or other forms of credit to pay off existing debt actually end up with even more debt. The monthly payment may now be much less that before, so again, it feels as if you're in less debt. All those cards that were maxed-out last month are now available. Now remember: if you've amassed enough debt that a loan is needed to pay it all off, chances are, you have a problem controlling your impulses, which means it won't take long for those paid-off credit cards to start calling your name. Indeed, for most consumers, the temptation is just too much, which explains why 70 percent of them end up with a debt consolidation loan as well as more credit card debt.

Alternatives to Debt Consolidation

Unless you are one of the few consumers who will not succumb to the temptation of available credit, you may want to consider debt counseling rather than debt consolidation. Through this program, a counselor works with you and your creditors to reduce your interest rates and monthly payment amounts. This reduces the amount of debt you owe as well as the amount of time it will take to pay it off. Additionally, as part of your agreement, you cannot rack up any more debt. In other words, your credit is off-limits. Because debt counseling negatively impacts your credit rating, many consumers shy away from the program. What they often don't consider, however, is that they may end up with more debt than before. And a large amount of debt can damage your credit score just as much as debt counseling.