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Does Debt Consolidation Affect Your Credit Score

How Consolidating With A Personal Loan Can Help Your Credit Score

How Does Debt Consolidation Affect Your Credit Score?

You can get a personal loan at your local bank, online bank, or through a peer-to-peer lender. Each bank or lender charges different interest rates and fees. Make sure you read the fine print so you understand what the lender charges. You should also pay attention to the loan’s APR so you can compare loans effectively.

A personal loan can help your credit score in the following ways:

  • A history of on-time payments: Payment history makes up 35% of your credit score. By simplifying your payments into one monthly payment, it may be easier to make your payment on or before the due date.
  • A lower credit utilization ratio: Your amounts owed, or credit utilization ratio, makes up 30% of your credit score. Paying off your credit cards will lower the amount you owe compared to your available credit, which is good for your credit score.
  • A more diverse credit mix: Your credit mix makes up 10% of your credit score; adding an installment loan to the mix of revolving debt helps mix things up.

How Does Debt Consolidation Affect My Credit Score

from the following information, from the highest impact on your credit scores to the smallest: Payment history, amount owed, credit length, credit mix and new credit. Debt consolidation may have a positive impact on your score if you maintain good credit habits, like paying bills on time and maintaining a low credit usage ratio.

Whenever you take out a new loan or line of credit, even in the debt consolidation context, your credit profile changes. Depending on the type of loan, you may increase your revolving credit or diversify your credit profile, both of which have some impact on your credit score. Therefore, applying for a debt consolidation loan will cause a credit inquiry to appear on your credit history.

Keep in mind that negative credit behaviors on a debt consolidation loan, including paying late, missing payments and/or driving up revolving credit balances can cause credit scores to decline.

How Debt Affects Your Credit Score

As you’ve probably already figured out, debt plays a big part in your financial life. Not only does it affect your spending ability, but it also has a direct impact on your and a direct impact on your ability to borrow money or pay a low insurance rate.

The amount of debt you have is one of the biggest factors that go into your credit score; your level of debt is 30% of your credit score. The credit scoring calculation considers your the ratio between your credit card balance and your credit limitfor each of your credit cards and your overall credit utilization. The higher your credit card balances are relative to your credit limit, the more it hurts your credit score. Maxed-out and over-the-limit;card balances are the worst of all.

Your credit score also takes into account how close your loan balance is to the original loan amount. Paying your loan balances;is better for your credit score.

Carrying a lot of debt, especially high , hurts your credit score and your ability to get approved for new credit cards, loans, and an increased credit limit. Even if your debt-to-income ratio is low, if your debt hurts your credit score, you could still be denied.

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When To Consider A Debt Consolidation Loan

A debt consolidation loan is the right idea if you:

  • Are struggling with multiple types of debt
  • Want to increase your credit utilization ratio
  • Want to build your credit by diversifying

Of course, it is also worth noting when it’s NOT a good idea to take a debt consolidation loan. If you are currently in major credit card debt due to irresponsible spending and you don’t intend to change these habits, walk away. While a debt consolidation loan can help alleviate your debt, it will only work if you have every intention of taking a more responsible course of action in the future. Clearing your debt quickly leaves a tempting void on your credit line, freeing up that line to more spending. If you aren’t careful, you could easily find yourself in even greater credit card debt than before you started.

What Do I Need To Know If Im Thinking About Consolidating My Credit Card Debt

How Does Debt Consolidation Affect Your Credit Score ...

When you consolidate your credit card debt, you aretaking out a new loan. You have to repaythe new loan just like any other loan. If you get a consolidation loan and keep making more purchases withcredit, you probably wont succeed in paying down your debt. If youre havingtrouble with credit, consider contacting a credit counselor first.;

Consolidation means that your various debts, whether they arecredit card bills or loan payments, are rolled into one monthly payment. If youhave multiple credit card accounts or loans, consolidation may be a way tosimplify or lower payments.; But, a debtconsolidation loan does not erase your debt. You might also end up paying moreby consolidating debt into another type of loan.

Before you use a consolidation loan:

  • ;Take a look at your spending. Its important to understandwhy you are in debt. If you have accrued a lot of debt because you are spendingmore than you are earning, a debt consolidation loan probably wont help you getout of debt unless you reduce your spending or increase your income.
  • Make a budget. Figure out if you can payoff your existing debt by adjusting the way you spend for a period of time.
  • Try reaching out to your individualcreditors to see if they will agree to lower your payments. Some creditors might be willing to accept lower minimum monthlypayments, waive certain fees ,reduce your interest rate, or change your monthlydue date to match up better to when you get paid, to help you pay back yourdebt.

Home equity loan

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Pros And Cons Of Debt Consolidation

Pros

  • Can improve your credit score.Your credit score should start to go up once you start making regular and on-time repayments.
  • Fewer payments. It will be much easier to manage your debt since youll only have one easy payment to remember.
  • Lower interest rates. You might be able to get a lower interest rate when you consolidate your debt, which will save you money over time.
  • Pay your debt off faster.With a lower interest rate, you can pay off your debts faster and have more money to spend on the things that matter to you.

Cons

  • Can lower your credit score temporarily.You may notice a temporary hit to your credit score, especially if you do a credit card balance transfer.
  • Potential upfront fees.You could end up paying a number of different fees such as origination fees, balance transfer fees or annual fees to consolidate your debt.
  • Higher interest rates. You might end up with a higher interest rate than you had to pay for your original debts if your credit score has gone down over time.
  • Not guaranteed to fix your debt problems. You could struggle to keep your spending habits in check which could lead you further into a cycle of debt.

When Does A Debt Consolidation Loan Not Make Sense

It does not make sense to consolidate if youre already to the point where you cannot afford all your monthly payments. Like I said a moment ago if youre not keeping up with your payments, a couple of things are probably happening:;

Youre likely spending almost half, if not more, of your monthly income on just your debt payments. In this case, you are likely carrying so much debt that the payment on a consolidation loan may be higher, which will not help you. It will actually make things worse. Sometimes a debt consolidation loan will lower your payment and relieve your budget, but sometimes it doesnt.;

At this point, you are also causing considerable damage to your credit score. Between maxed-out credit cards killing your credit utilization ratio and missed payments, your credit score is taking a one-two punch right to the gut. Youll be charged a higher interest rate on your consolidation loan or you run the risk of not qualifying at all.;

If your income is so low that you use your credit cards to supplement the cost of living, you really dont want to get a consolidation loan. Thats because your income isnt sufficient enough to meet your basic needs, so you were left reaching for your credit cards to fill the gap. Thats not a discipline problem, thats survival. You cant change a bad habit that doesnt actually exist because theactual problem is that the cost of living is higher than your income.;

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Will Debt Consolidation Show Up On My Credit Report

Debt consolidation can impact your credit history, and in turn, influence your credit score. While information such as the loan purpose isnt reflected on your credit history, a loan used for debt consolidation will appear on your credit accounts and usage profile. Even though debt consolidation can impact your credit history, positive credit behaviors, including on-time payments and maintaining a low credit utilization ratio ;can lead to a higher score and credit rating improvement over time. On the other hand, debt consolidation loans, like other forms of personal credit, may lower your score if you make late payments and/or continue to raise your credit utilization ratio.

How Can Debt Consolidation Hurt My Credit Score

Debt settlement-Does it hurt your credit score?

While there’s a definite upside to the ease of a single payment and thetemptation of a lower interest rate, consolidation can hurt your creditscore in a few ways. But some simple strategies can help minimize theimpact.

  • New credit inquiries: Each time you apply for a loan or a credit card, you’ll incur a hard inquiry on your credit report. Since , several inquiries and new credit accounts in a short period can lead to a drop. To minimize the impact, check your credit score in advance, so you can confirm with the lender or card issuer that your credit score is sufficient for the loan or credit card you want. And then apply for just one loan or card for your debt consolidation.
  • Increased credit utilization: If you use a new loan or credit card to consolidate and then close the credit lines you’ve rolled into the new debt, you could decrease your available credit and thereby increase your credit utilization. A better choice: Instead of closing credit cards, cut up those that you’ve moved your debt out of. That way, you won’t be tempted to use them, but they’re still in your name and contributing to your overall available credit.
  • Lower age of credit: New accounts can lower the average age of your credit accounts. Credit history length accounts for roughly 15% of your overall credit score. This is another reason why keeping unused credit card accounts open after consolidation is so important.

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Personal Loan Vs Balance Transfer Card: Which Should You Pick

Personal loans and balance transfer cards are two options to consolidate your debt. If youre deciding between the two, here are some things to keep in mind:

Personal loans
  • More options for poor or fair credit
  • Typically have lower interest rates than credit cards
  • Might come with 0% APR introductory offer
  • Could help you establish longer credit history if you keep the card open
  • Might offer rewards or other perks
Cons
  • Might come with origination or other fees
  • No rewards or other perks
  • Could be tempting to rack up a balance again
  • Typically come with 3% to 5% balance transfer fees

Can You Avoid A Debt Consolidation Loan And Still Pay Off Your Debt

The short answer is yes. But it depends entirely on how much debt you have and how much money you make. You need to have disposable income left over after you cover your basic living expenses and make all your monthly debt payment obligations. If you want to pay down your debt without a consolidation loan, you two have options:

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Using A Personal Loan

A personal loan is an unsecured loan from your bank, which is generally used to consolidate debt or make a big purchase. If you’re using it to pay down debt, the strategy works like this: you use the loan to pay off all your credit card balances and then focus on eliminating the loan balance.

Consumers who take out personal loans pay down nearly 60% of their credit card debt on average, TransUnion finds, which brings the average balance down from $14,015 to $5,855.

But these loans don’t universally offer cheaper interest rates. And like all loans, you’ll need to apply and get approved. So if you have bad credit, you may risk getting declined, or approved with a high interest rate. On average, those with credit scores below 680 will be paying higher interest rates for a personal loan than the average credit card APR of 16.97%, according to an analysis by loan marketplace Credible.

For personal loans, the rate not only depends on your credit, but also on the length of the loan, as shorter loans tend to have lower APRs. If you feel that paying off your debt will take longer than three years, you may be subject to a higher rate, Credible finds.

Even if you do find a low interest rate loan, you also need to look at all the numbers, Roberge tells CNBC Make It. That’s because taking out a loan could come with origination fees, and paying those expenses could cancel out any savings you might generate by having the loan be at a lower interest rate than your credit card, he adds.

Paying Off Your Debts

Do Debt Consolidation Loans Hurt Your Credit Score?

If youre working with a;debt settlement company, youll be advised to stop making;monthly payments;on the debts that are being settled. Instead, the money that youd otherwise earmark for debt payments will most likely go into a savings account maintained by the;debt settlement company. Deposits into that account stretching out over the course of perhaps several years end once youve accumulated enough money to cover the settlement amount.

So, lets say a creditor agrees to settle your;credit card debt;for 50% of what you owe. If the amount you owe totals $15,000, then the creditor would theoretically get $7,500 in the form of a;lump-sum payment. And the creditor would forgive the remaining $7,500. But be aware that the;IRS;may tax the amount of;forgiven debt.

Its also possible that while youre saving up the money to cover a;lump-sum payment, you may be hit with;late fees;and your balance may go up This can cause your;credit score;to dip even more.

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Best Debt Consolidation Loans Of September 2021

LightStream is the online lending division of SunTrust Bank. LightStream offers rates starting as low as 5.93% on personal loans for debt consolidation. The rates will vary though by amount of loan and duration of the loan.;

If you qualify, the lender may let you borrow up to $100,000. When you add in the benefit of no fees, LightStream may be an affordable option to consolidate other high-interest debts.

  • Rates as low as 5.93% on debt consolidation loans when signing up for auto pay

  • No fees

  • LightStream guarantees to beat any qualifying rate from another lender

  • Good credit is recommended

  • No pre-approvalsyou must allow a hard inquiry of your credit report to check your rate

Other important information:

Read the full review:;LightStreams Personal Loans

Closing Old Credit Cards Reduces Available Credit

If youve been spooked by the previous warning, dont go too far to restrain your spending. That is, dont go as far as to close those old, balance-free credit cards. That will actually hurt your credit score too.;;

Heres an example of how closing unused credit cards could raise your credit utilization ratio, using the same four card scenarios:;

Card and Credit Limit
28% 47%

See how those empty cards can work in your favor while you pay off that balance transfer card? So instead of closing unused cards, tuck them away while you pay down the consolidated debt balance. If youre likely to buckle, lock the physical cards in a safe, or freeze them in water. Make sure you remove all automatic payments from those cards and clear saved card details from any online shopping accounts to eliminate further temptation.;

If overspending is a serious concern and your budget is already under pressure, closing empty cards may be in your best interest after all. Your score may dip temporarily, but you can more easily bounce back from that kind of a hit than from more suffocating debt. Just make sure to close cards with caution.;

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How Consolidating Debt With A Balance Transfer Credit Card Can Hurt Your Credit

Balance transfer credit cards may seem perfect, especially if you can snag a 0% intro APR and/or attractive rewards, but they can harm your credit score if:

  • You max out your balances: If you use most of the balance transfer credit line extended to you, the high balance will cause your credit score to drop.
  • The card significantly decreases your credit age: A new credit card decreases your average account age.
  • Your credit limit isn’t high enough: If you can’t get a high enough credit limit on your balance transfer card, you won’t be able to transfer all of the debt from your other credit cards. You want the new card’s credit limit to be high enough to zero out your existing credit card balances and to lower your utilization ratio.

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