Many consumers turn to debt consolidation programs after struggling with payments and drowning in debt. These consumers usually have a damaged credit score already, so getting help is the first priority, not saving the credit scores. If credit score is a concern for you, then it is best to carefully review each program and ask how the payments are reported to the credit agencies.
Debt Consolidation Agencies
Consumers approaching debt consolidation first work with a counselor who reviews income, expenses and debt to create the best strategy. Reputable companies inform clients if debt consolidation is a viable option for them. The counselor will offer a plan to consolidate high interest credit card payments into one affordable lump sum. Debt consolidators negotiate lower interest rates on the client's behalf in return for a small fee taken from the client's payments. Credit card companies are happy to work with debt consolidators because they will recover most of the debt and can avoid writing it off.
Drawbacks of Using Debt Consolidators
While most debt consolidation companies are reputable, there are some that may cause damage to your credit scores. Some companies have been known to take the monthly payments from the consumer without turning them over to the creditor. There is also a problem if they make the payments late. Both scenarios damage your credit even further. A few offer debt consolidation loans that have high interest rates, meaning the consumer will have a lower payment but end up paying more over time.
How Debt Consolidation Affects Credit Scores
Debt consolidation helps improve credit ratings because payments are made on time and kept current. However, there can be a negative effect if the agency closes the credit card accounts. This is because the overall available credit will decrease, but the debt balance stays the same. The result is a credit portfolio that appears to be maxed out. Closing older accounts is not recommended because they have a longer credit history, and payment history accounts for 35 percent of the FICO score.
If the debt consolidation program negotiates a reduction of debt, there may be a statement on the account reflecting that the balance was paid at a reduced rate. This is viewed negatively by lenders due to the fact that the original balance was not paid in full.
Alternatives to Debt Consolidation
If your debt is not extreme, paying higher minimum payments could help pay down debt faster than using a debt consolidation agency. Debt consolidation companies negotiate with lenders and help pay down high interest debt first, which the average consumer can do himself. Debt counseling is also an alternative to consolidation. Debt counselors help consumers develop budgets and track spending habits to develop a debt reducing strategy.
Other Types of Debt Consolidation
Consumers can transfer credit card balances to lower interest cards to pay off accounts quickly. It is important to close the old accounts yourself, otherwise it will seem as if the credit card company closed the account and this reflects negatively on the credit report.
If there is equity in your home, obtaining a home equity loan to pay off debt carries many advantages such as low interest rates and a tax deduction. Using a home equity loan means no negative statements on the credit report. A "cash out" refinancing loan offers the same benefits.
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