Debt consolidation loans are a good option if you can find a loan that has a lower interest rate than your current credit card or loan interest rates, and if you are completely dedicated to actually paying off your debt. It has less of an impact on your credit score than bankruptcy and debt management plans. However, if used incorrectly, a debt consolidation loan can quickly make your credit score even worse.
Credit Score
Debt consolidation has a much lower impact on your credit score than bankruptcy. It is considered the lesser of two evils, which means that even though taking on a debt consolidation loan will leave a negative impact on your credit score, the effects aren't nearly as long-lasting or as drastic as they would be if you claimed bankruptcy. With a debt consolidation loan, you may have difficulty getting new credit while you're paying off your balance; however, once lenders see that you paid off the loan successfully, they will consider lending you money. If you claimed bankruptcy, you would likely have problems getting new credit for the entire 10-year period that the bankruptcy is on your credit report.
Convenience
Instead of having multiple monthly payments toward your debt, you'll just make one lump payment toward the loan. A debt consolidation loan is a convenient way to pay down your debt and is particularly useful for those who have problems making payments on time to multiple accounts. Financial advisers recommend setting up an automatic payment to boost your credit score, since on-time payments are one of the top factors in calculating your score.
Quicker Payoff
If you are fully committed and can get a lower interest rate than your cards, you can pay off your debt more quickly and for less money. One of the issues people run into with debt consolidation loans is that the loan clears out their previous balances, which frees up credit. Many are tempted to use the newly freed credit, at which point they spiral further into debt, damaging their credit even more. Also, you must make sure that the interest rate for the loan really is lower than the interest rate for your credit cards. Remember that it's not just about having a lower monthly payment; it's about paying less overall.
Warnings
You must make a commitment to digging yourself out of debt before taking on a consolidation loan or else it will only cause your credit more damage. Stop spending on your cards, do not procure more loans and work out a budget so that you can make your debt consolidation loan payment on time each month. If you commit to limiting your spending and making on-time payments, the negative impact on your credit that resulted from the inquiry from your consolidation loan application will be reversed because of a lower debt-to-credit ratio.
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