How Does Debt Consolidation Affect Your Credit Report?

Debt consolidation may have a severe impact on your credit report if you aren't educated on making the right choices and managing your money during the consolidation process. It's vital that you create a plan prior to taking on consolidation loans, debt management plans and balance transfers to avoid falling into traps that get you further and further into debt. However, if used properly, these methods may get you out of debt faster and for less money.

Consolidation Loans

Since consolidation loans are new credit, your lender must make a hard inquiry into your credit report, which creates a small negative effect on your credit score. Thereafter, the consequences of a consolidation loan are based on how responsible you are in repaying it. Since a consolidation loan effectively wipes out your previous balances, you must resist temptation to continue contributing to your debt. Giving into using the newly freed credit is one of the biggest pitfalls for people using consolidation loans. The appearance of a consolidation loan on your credit report may also make it difficult to obtain new credit, since lenders will see that you've had problems managing your money in the past.

Debt Management Plans

The only way to get on a debt management plan (DMP) is if a credit counselor recommends one for your specific financial situation. It's viewed as the last stop before bankruptcy, and you must be behind on payments and having trouble making payments to qualify for one. Your credit counselor will work with your creditors to negotiate lower interest rates and/or lower payoff balances. A DMP is viewed as a negative mark on your credit report, since it indicates that you weren't able to pay back the full amount of your debt. Also, if your credit counseling company doesn't pay your creditors on time, your credit score will plummet. It's vital to check with the Association of Independent Consumer Credit Counseling Agencies or the National Foundation of Credit Counseling before choosing a credit counseling company.

Balance Transfers

Balance Transfers may have the worst effect on your credit. For one thing, when you open a new credit card account, the creditor must make a hard inquiry into your credit report. Also, the credit bureaus don't differentiate between a high balance that comes from a transfer and a high balance resulting from a large purchase; therefore, the transfer may weigh on your credit score. It also appears on your credit report as an additional debt. Also, if you keep opening new accounts to take advantage of low introductory rates, your credit score will be negatively impacted. Closing old accounts further impacts your credit score in a negative way.

Considerations

Debt consolidation methods decrease your chances of qualifying for new credit and getting good interest rates in the future, so it's best to explore your other options first. Often, the rates advertised for debt consolidation loans are only for those with stellar credit, and you may actually save more money by requesting lower interest rates with your current credit cards.