When you are having trouble managing your debt payments, one solution is to consolidate the debts by taking out one large loan, such as a personal loan or home equity loan, and using it to repay all your other debts. The impact of debt consolidation on your credit score depends on the data on your credit report before consolidating and what method you choose for consolidation.
New Loan Effects
When you take out a debt consolidation loan, this has several immediate negative effects on your credit. It generates a credit inquiry on your report, which usually causes your score to drop by five points or less. It also creates a new account, and this hurts your score by adding a recent account and by shortening your average account age.
Benefits of Consolidation
Debt consolidation can improve your credit score in a few key ways. It can move credit card debts into an installment loan, which reduces your debt-to-credit ratio (or credit utilization) on your credit cards. If your cards were maxed out (100 percent credit utilization), you probably will see an increase in your credit score because the cards have a lot of available credit again, thus reducing your debt-to-credit ratio. The debt consolidation also brings any accounts that were delinquent into the status of being paid as agreed. This can boost the portion of your score that considers your payment history.
Considerations
After you take out a debt consolidation loan, you must make the payments on time to avoid damaging your credit. Being late on payments on your consolidation loan will damage your score just as much as being late on your previous debts would. In addition, after consolidating debt, you may want to make your regular purchases in cash rather than accumulating debt on credit cards again. If you accumulate more debt that require monthly payments, you might not have enough money to make the consolidation loan payments, which also hurts your score.
Debt Consolidation vs. Debt Management
Some people confuse debt consolidation and debt management, which are different techniques that have different effects on your credit. In debt consolidation, you obtain a new loan and use it to pay off your other debts. In debt management, you enroll in a program in which you make a payment every month to the company that manages your debts. If the debt management company is irresponsible and makes late payments on your debts, this could hurt your credit score. In addition, your credit report will contain a note that you are enrolled in debt management. Although this note does not affect your credit score, potential lenders may see it and be wary of offering you new credit.
0 comments:
Post a Comment