Does Debt Consolidation Affect Your Credit Score?
Does debt consolidation have any impact on your credit score?
Debt consolidation can seem like a good idea if you have several debts that you are struggling to manage. This involves the use of another loan to pay other forms of credit you may have undertaken. This means that you only have to make one payment every month rather than many payments.
Though debt consolidation helps to organize your payments, many citizens ask – does debt consolidation harm your credit score? Yes, debt consolidation affects credit scores, but the effect depends on the circumstances of each borrower.
How does Debt Consolidation impact Credit Rating?
When you go for a debt consolidation loan, you are getting a new line of credit and this means that your score will initially drop. Nonetheless, these debt consolidation loans are known to help increase your credit score in the long run if used appropriately. Here are some of the ways debt consolidation affects your credit score.
- New Credit Inquiry: When you apply for a debt consolidation loan, the credit check done by the lender is of the hard type and is seen on credit reports as a negative factor that brings down your score. Several applications give rise to other questions, which in turn affect the score.
- Closed Accounts: When you use a consolidation loan to pay off debts, the credit card and loan accounts are closed. This alters your credit mix and can either improve or harm your credit score.
- Credit Utilization Ratio: A consolidation loan can immediately enhance your credit utilization ratio which is the ratio of the credit limits that you are currently using. This ratio is calculated and makes up 30% of your credit score; therefore, a lower ratio improves your score.
- On-Time Payments: When debts are consolidated to allow for a single monthly payment, individuals are less likely to default on the payment. Paying all your bills on time increases your score.
- Repayment Period: Debt consolidation loans are typically repaid over a time frame of three to seven years. The longer you take to clear your credit the more strain it puts on your credit rating.
From this, you might note that debt consolidation is indeed capable of either putting your credit score down or increasing it depending on how you manage your consolidation loan. At first, this change is not very large, but with time, your score can change to a greater degree (either positive or negative).
Tips to Protect Your Credit Score
If you want to consolidate your debts without hurting your credit score, consider the following tips.
- Comparison shop: Submit credit applications to several lenders within 45 days so that all those requests will be reported as a single credit check rather than several hard ones.
- Ask about a soft credit check: Check whether some of the lenders conduct prequalification checks, which let them look through the credit data without causing an impact on the credit score of the borrower.
- Pick an affordable payment: Do not select new loan terms without determining your debt-to-income ratio so that payments aren’t a strain.
- Pay on time each month: Some of the measures that should be taken include arranging for automatic payment through your lender to avoid missing payment dates after consolidation.
- Pay down balances: Paying beyond the minimum to ensure that the amount being paid off is less than the total balance due every month.
- Monitor credit regularly: It is advisable to monitor your credit score every few months so you can determine the effect that consolidation has had on your credit as compared to the impact of your previous debts.
The Bottom Line
Thus, debt consolidation offers convenience in terms of number of monthly payments that need to be made. If consolidation loans are taken correctly, they can even have an overall positive, albeit small and short-term, effect on your credit score because they allow you to demonstrate that you are capable of repaying your debt on time. Consolidation should be managed cautiously to safeguard credit.
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