Applying For New Credit
The first way most debt consolidation options can affect your credit score is through the credit inquiry that occurs when you apply for a loan or credit card. For most people, these hard inquiries knock fewer than five points off your credit score, according to FICO.
Each inquiry remains on your credit reports for two years, but theyll only impact your FICO credit score for one year.
Can I Still Use My Credit Card Accounts After A Debt Consolidation Loan
Technically you can – although of course you risk re-creating the problem that you started with. Generally, people use debt consolidation loans as a way of taking control of their finances, with the aim of getting out of debt altogether. Using new debt defeats the purpose, and because it can be so tempting, lots of personal finance sites recommend you keep your credit card accounts open, but cut the cards up. The aim is for your credit card balances to stay at zero.
Is Debt Consolidation Right For You
Debt consolidation can be very helpful for some borrowers, but itâs not right for everyone. If you have healthy financial habits, are able to pay your bills on time, and have a good enough credit score to get a personal loan with a lower interest rate, you may be a good candidate. If you have poor credit but you can make a single monthly payment consistently, consolidating your debt through a debt management plan is probably your best bet.
Also, if youâre having trouble keeping track of your monthly payments and due dates or you have a lot of high-interest debt, consolidating your debts can provide many benefits. If you qualify for a lower interest rate, youâll save money in the long run, and more of your monthly payment will go toward the principal rather than paying the interest.
Youâll also only have a single monthly payment to worry about, which makes it easier to make on-time payments and avoid missed payments. In addition to making your life easier, this arrangement can also help boost your . Plus, your monthly payment may be less than what you were paying before, which means youâll be saving money every month, too.
Evaluate your finances.
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The Debt Avalanche Method
The debt avalanche method is an approach to paying off debt that, if done properly, can accelerate your debt payoff and save you money along the way.
This strategy has you make just the minimum payment on all of your debts except for the one with the highest interest rate, to which you’ll put as much as you can. Once that debt is paid off, take all the payments you were making toward it and apply them to the account with the next-highest interest rate until it’s paid off.
Repeat this process until all of your debts are paid in full. Because it targets your high-interest debts first, the debt avalanche method can save you more on interest charges than other payoff methods.
Pros Of Debt Consolidation
One of the main advantages of going through the process of debt consolidation is being able to handle your bills. First, try to negotiate your bills down as much as possible. Yes, thats right it just takes calling and asking sometimes.
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It helps to know the advantages of debt consolidation so you know if the risk of using debt consolidation is worth it to you. You get to merge all your debts into one larger debt.
If you are feeling overwhelmed about your debt then debt consolidating can make it easier to manage. One payment can be much easier to manage than a bunch of little ones. It can also improve your credit as you start to go through the process. As long as you are making consistent monthly payments, you decrease your debt and this will decrease your debt-to-income ratio as well.
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Ways To Consolidate Your Debt
There are several different ways to consolidate debt:
- Debt consolidation loans.Debt consolidation loans are a type of personal loan available through banks, credit unions and online lenders. With this type of loan, lenders may pay off your debt directly or provide the cash for the borrower to pay off their outstanding balances.
- Personal loans. With a personal loan used for debt consolidation, you take out a new loan from a bank, credit union or another lender to pay off higher-interest debts, such as credit card debts or other bills.
- Balance transfer credit card. If you have good enough credit, you can transfer the balance of several credit cards to a new balance transfer credit card at a lower interest rate, sometimes at 0% APR for an introductory period.
- Home equity loan. If you own your home and have built up enough equity to qualify, you may be able to use a home equity loan or home equity line of credit to consolidate your debt at a lower interest rate.
- Cash-out mortgage refinance. A cash-out mortgage refinance gives you the option to refinance your home for more than the outstanding balance. You can use the difference in cash to pay off outstanding debts.
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.
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Monitor Your Credit Closely After You Consolidate
Whether you use a loan, a balance transfer card, or a debt management plan to consolidate, its always a good idea to keep an eye on your . You want to make sure that the balances on your individual accounts reflect that they have been paid down. You also want to watch out for misreported missed payments.
If you find any errors in your credit report following consolidation, you should go through the credit repair process. This will allow you to correct the negative items that may be dragging down your score.
Understanding Different Kinds Of Debt
Understanding debt means recognizing the different forms and the various roles it can play. There is a thing as too much debt. While debt-free living is a nice concept, its not very common. Debt can be a tool that is useful. Understanding the different types of debt can be the first step toward determining how to pay it off.
For many people, taking on a mortgage is the largest debt they will experience. However, homeownership is often encouraged. During the Great Depression, the idea of a 30-year mortgage became the norm to allow more people to purchase a home. Mortgages are the kind of debt that are most often refinanced.
Vehicle payments arent the same as buying a home but they do have a few things in common. There are potential downsides of auto financing but it can be necessary to have a car. The secret to making an auto loan good debt instead of bad is to do your homework before you start looking. Pre-approved financing can give you more flexibility and some time to think before you commit.
This is a riskier type of debt than an auto loan or mortgage. With cars and homes, there are different calculations you can use to determine whether you are getting a good rate or choosing the right model or location. There is still an element of risk but it doesnt compare to business risk.
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How Consolidating With A Personal Loan Can Help 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.
Why Use Debt Consolidation
Debt consolidation can save you money. Debt consolidation with a new low-interest rate loan will help you organize your expenses. In this case, the savings will be done better and your worries about repayment will be easier.
This way you have an account that is easy to manage. When the number of accounts increases, the possibility of mistakes increases and you may forget some payments. Delays in payment time damage the credit score. So a debt consolidation method can help maintain and improve your credit score.
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How Consolidating With A Balance Transfer Credit Card Can Help Your Credit Score
Finding the right balance transfer offer is important, whether you use your current credit card company or find a new one. Compare your options, paying close attention to the terms, such as length of the intro period and the rewards offered. As with a personal loan, always read the fine print to understand the terms and fees of the credit card, such as late-payment fees, annual fees, or over-the-limit fees.
The right balance transfer credit card can help your credit score in the following ways:
- It lowers your credit utilization ratio: Opening up a new credit line decreases your total outstanding debt compared to your total available balance.
- It simplifies payments: With only one payment to make each month, you may have an easier time avoiding delinquent payments in the future.
- It eliminates delinquent, high-interest debt: If you’re behind on your credit card payments, wrapping that delinquent debt into your balance transfer credit card eliminates the delinquency. While the late payments you made won’t disappear off your credit report, timely payments on the new credit card can help your score increase.
Make Your Payments On Time
Youve likely heard that on-time payments are a key factor in how high your credit score is. In fact, even having one miss on your payment history can mar your credit. Thats why its vital to make sure you always make your debt payments on time.
Fortunately, it can be easier than ever to keep up on your bills when you use a debt consolidation strategy like a personal loan or a balance card transfer. Thats because rather than having multiple monthly payments, as you likely had before, youll only have one monthly payment to keep track of.
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Do Credit Card Consolidation Loans Hurt Your Credit
There are several things that can bring your credit score down. One of them is a hard inquiry.
When you apply for a loan or balance transfer card, your lenders will want to take a close look at your credit score to see the details of your financial history. This inquiry alone can take as much as five points off of your credit score.
Also, some lenders may charge a prepayment penalty if you pay off your balance early. This is most common among longer-term loans like mortgages, but some credit cards may also carry similar penalties.
While these things may lower your credit score slightly, keep in mind that your FICO score is also damaged by using too much of your available credit. The points you lose through a credit consolidation may be evened out by paying off your balance.
Dont Make A Mistake With Your Timing
This guideline is particularly important should you choose to use a balance transfer credit card. Remember the reason its an attractive vehicle to consolidate your debt is because it comes with a low introductory rate that will allow you to pay off your debt with as low of an interest rate as possible.
However, once you get out of that promotional period, your rate can zoom. If you havent paid off your debt in time, youll be stuck paying it off at this much higher rate, which can harm your finances as well as your credit score.
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A Reduced Credit History
Another factor in your credit score is how long you have had your accounts. So whenever you open new credit accounts, it can draw down your average of your older accounts. However, your FICO® Score will still take into account the age of your oldest account, so make sure not to cancel it right away.
While there will be long-term upsides to your credit, remember that you will only reap the benefits if you practice good personal finance hygiene with these new loan vehicles.
How Debt Consolidation Affects Credit Scores
When you consolidate debt, you pull several levers at once that help or harm your credit. Here are some short-term causes of a credit score drop when consolidating debt:
- New credit applications The first possible damage to your credit scores can happen before you even consolidate: When you apply for that personal loan or balance transfer credit card, the lender will perform a hard inquiry on your credit, which will lower your credit scores by a few points.
- New credit account Opening a new credit account, such as a credit card or personal loan, temporarily lowers your credit scores. Lenders look at new credit as a new risk, so your credit scores usually have an additional temporary dip when taking out a new loan.
- Lower average age of credit As your credit accounts get older and show a positive history of on-time payments, your credit scores rise. Opening a new account adds a new newest account and lowers your average account age and may lower your scores for a while.
But it isnt all bad. Here are some positives for your credit scores from a debt consolidation:
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Consolidating Debt With A Balance Transfer
Balance transfers, in which credit card debt is transferred onto a lower-interest or zero-interest card, works if you have a good to excellent credit score, meaning 700 or better.
If you fall below 700, you may not qualify and if you do, it will likely end up costing you money in fees, a short time limit on the introductory rate and youll be back where you started. Or worse.
Paying More Interest In The Long Run
Debt consolidation loans can lower monthly payments and provide significant relief for consumers who are struggling under a heavy debt load. However, consumers need to be aware that consolidation loans can often mean paying more interest in the end. Consumers who utilize the equity in their homes are likely looking at significant closing costs and long loan terms. This means that consumers could be paying interest on their debt for up to 30 years.
Average Age Of Credit
Another factor in determining your credit rating is the average age of your credit accounts. This differs from the length of overall credit history. The first time you took out a loan or credit card, you established your credit history. But, the average age of credit looks at how long each individual account has been open. It makes up 15% of your credit score.
If you get a new line of credit, your average age of credit will decrease, which can cause your credit score to drop. While this change probably wonât be significant, itâs worth keeping in mind.
Racking Up More Debt After Consolidation Raises Utilization Ratio
One of the biggest risks associated with consolidation is running up new debt before youve paid off your old balance. If you succumb to the spending temptation of a newly paid off credit card, any credit score improvements you see will quickly disappear.
Heres why: When you consolidate your debt into a new account to pay off other cards, your overall amount of available credit increases, lowering your . The lower that ratio is, the better your FICO credit score will be.
But, if you dont leave those credit limits alone on your older cards, youll get yourself in trouble again. Heres an example of how piling new debt on top of consolidated debt will increase your credit utilization ratio and be a drag on your score:
|Card and Credit Limit
Rein in your spending habits, or youll be juggling multiple debts again, including a large consolidated debt account. This could soon overwhelm your budget and lead to late payments, or worsedefault.
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