Saturday, April 19, 2008

What Are the Negative Ramifications of a Debt Consolidation Loan?

Although a consolidation loan is seen as a dark mark on your credit report, the negative impact that may come from obtaining a consolidation loan comes more from how you use the loan. If you are dedicated to paying off your balances and keeping them paid off, the effect of the loan on your credit score -- and your life -- may be positive. However, many people in need of a consolidation loan have deep-rooted issues with money that end up luring them into using the credit freed by a consolidation loan.

Credit Score

    Whenever you apply for new credit, the lender must make an inquiry into your credit report. That inquiry has a negative effect on your credit score. However, if you remain committed to paying off your debt and keeping it paid off, the positive effect will far outweigh the impact caused by an inquiry.

Obtaining New Credit

    Other than the inquiry, the consolidation loan itself doesn't weigh down your credit score; however, having a consolidation loan listed on your credit report may make it difficult for you to obtain new credit while you're paying off the loan. It demonstrates that you have had trouble with your finances in the past, which may make creditors hesitant to lend to you. The consolidation loan may stay on your credit report for up to seven years.

Using Freed Credit

    The biggest negative impact comes not from the consolidation loan itself but from abuse of the loan. According to Bankrate.com, 70 percent of people who take on a consolidation loan end up with the same or more debt within two years. The loan pays off your former balances, freeing up that credit -- and you must be absolutely committed to keeping it free. If you continue to contribute to your debt, you'll increase your debt-to-credit ratio, which is one of the largest factors in determining your credit score.

Considerations

    Since it's difficult to obtain new credit when you take on a consolidation loan, and because of the temptation you may experience once the loan pays off your balances, it's wise to consider your other options first. Often, the low rates advertised for consolidation loans are available only to those with exceptionally good credit. Talk to your creditors to see if you can lower your interest rates. You may find that you get a better deal by lowering your credit card rates than by taking on a loan.

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