A Debt Consolidation Can Help You Lower Your Monthly Payment And Help Improve Your Credit But Only If You Stick To A Plan To Pay Down Your Debt
If you have high-interest credit card balances on multiple accounts, just making those monthly payments can be so tough that you cant afford the things you really need or want much less save any money. It may also stress you out. In this situation, debt consolidation might be a smart decision. But before you get started, lets dig in to understand how debt consolidation can affect your .
Paying Off Your Debts
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.
Get Lower Interest Rates
As of November 2021, the average credit card rate is around 16 percent. Meanwhile, the average personal loan rate is below 11 percent. Of course, rates vary depending on your credit score and the loan amount and term length, but youre likely to get a lower interest rate with a debt consolidation loan than what youre currently paying on your credit card.
Takeaway: Debt consolidation loans for consumers who have good to excellent credit typically have significantly lower interest rates than the average credit card.
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How A Personal Consolidation Loan Can Affect Your Credit
Since this falls into the credit category, applying for a personal consolidation loan will result in a hard inquiry on your credit report. As a result, your credit score may decrease by a few points.
Getting a new loan can also decrease your credit age, which measures the average age of all your accounts. But how much it decreases your score depends on how many other accounts you have and the age of each of those accounts. The more, old accounts you have, the less a new account will decrease your credit age. This factor accounts for 15% of your score.
Luckily, loans do not affect credit utilization, which comprises 30% of your overall credit score. Getting a loan wont drive up this ratio.
And if you manage the personal consolidation loan effectively by making payments on time, your credit history and score will be in good standing. Conversely, missing payments will have the opposite effect. Credit history is the biggest factor in credit score, carrying 35% of the weight in your score. As a result, any missed loan payment would have a serious negative impact.
Debt.com can help you find the best option to consolidate debt.
Being Late Or Missing Payments Clouds Credit History
Its absolutely crucial that you make all your debt consolidation payments on time each month until the balance is repaid. Payment history has the biggest influence on your FICO score, and records of late payments will damage it.
If you ignore the debt consolidation balance and stop making payments altogether, your account will become delinquent and the lender will send it to collections. Collection records stay on your credit report for seven years and until that time passes, your credit will suffer immensely.
If you are suddenly facing financial difficulties and worried youll miss a consolidated debt payment, call your credit card or loan issuer before your payment becomes late and your credit score takes a hit. There may be financial hardship options available.
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It Wont Solve Financial Problems On Its Own
Consolidating debt does not guarantee that you wont go into debt again. If you have a history of living beyond your means, you might do so again once you feel free of debt. To help avoid this, make yourself a realistic budget and stick to it. You should also start building an emergency fund that can be used to pay for financial surprises so you dont have to rely on credit cards.
Takeaway: Consolidation can help you pay debt off, but it will not eliminate the financial habits that got you into trouble in the first place, such as overspending or failing to set aside money for emergencies. You can prevent more debt from accumulating by laying the groundwork for better financial behavior.
How Can Debt Consolidation Help My Credit Score
Depending on how you choose to consolidate, your credit score mayexperience a positive bump. Here’s how consolidating could improveyour score, based on how credit scores are calculated.
- Lower your credit utilization: Credit utilization accounts for 30% of your credit score. The less credit you’re using of your total available credit, the better your credit score will be. Opening a new account increases your available credit while your total debt remains the same. This can increase your score because you’re now using less of your available credit.
- Lead to faster debt payoff: Since less debt means lower credit utilization, paying down your debt faster helps you to increase your credit score faster. Here’s how debt consolidation can help with that: If your total monthly payment goes down as a result of a lower interest rate, you can afford to pay more than the minimum on your consolidated debt each month. If you do this, you’ll pay off your debt more quickly than you would’ve without consolidating.
- Reduce or eliminate late payments: A good payment history accounts for 35% of your credit score. Debt consolidation can help you achieve this goal in two ways. First, the more bills you have to juggle, the more likely you are to let something slip through the cracks. And second, by reducing the total amount you owe every month , you also reduce the chances that you lack the funds to make your monthly payment.
Positive Effects Debt Consolidation Can Have On Your Credit Score
- Reduces your debt to credit ratio – For example, opening up a new line of credit, such as a balance transfer credit card, will reduce your debt to credit ratio, for a given amount of debt. To illustrate this, imagine if you had a total of $10,000 of available credit, and you had $5,000 in outstanding balances. You would have a debt to credit ratio of 50%, which is higher than most credit experts would recommend. Then, letâs say that you were to then open up another credit card with a $5,000 limit, and transfer your outstanding balances to it. You would now have $15,000 of available credit. With the same $5,000 of outstanding balances, youâll now have a debt to credit ratio of just 33%. While thatâs still somewhat high, itâs better than before and can improve your credit score.
- Reduces your chance of missing a payment – When youâve consolidated your debt, youâve reduced the number of accounts you have with outstanding balances, which can also help to improve your credit score. But most important are the indirect effects of consolidating your debts. By having fewer outstanding balances, youâll have fewer payments to make, reducing your chance of missing a payment. And as most people are aware, missing payments will severely hurt your credit. And if youâve consolidated your debts to a credit card with a 0% APR promotional financing offer, then youâll be able to pay down your balance sooner than you would if you had to also pay interest charges.
Will A Debt Consolidation Loan Affect My Credit Score
Now you know how a debt consolidation loan can affect your credit scoreboth negatively and positively. If youre looking to consolidate your debt with a loan that provides flexibility and one affordably low monthly payment, call our team at to speak to a loan specialist or use our Payment Estimator to see how affordable your monthly payment could be in 30 seconds or less.
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How Does Debt Consolidation Affect My Credit Score
Debt consolidation involves combining a variety of bills related to unsecured debt that can include credit card debt, personal loans and medical bills into one streamlined monthly payment. There are often many benefits to debt consolidation including a more manageable monthly payment, a lower blended interest rate, lower interest expense over the life of the debt, and a simplified payment process that makes it easier to keep track of payments and avoid late fees.
In the case of debt settlement, the benefit can involve a reduced payment amount. With all of these potential benefits, you may be wondering about the potential drawbacks of debt consolidation. Are you wondering how debt consolidation affects your credit score? Debt consolidation can either hurt your credit or help it, depending on your payment plan. Learn more!
Compare Loan Options From Lenders
Once you have your credit score along with the sum total of all your debt and the interest rates, you can begin to look through different loan offerings. Traditionally, debt consolidation loans will come from banks, credit unions, or online lenders. To get a loan to consolidate debt, evaluate the various offerings from these sources and the interest rates they provide. Only after comparing all your options should you settle on a lender.
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How Will A Debt Consolidation Program Impact My Credit
A DCP or debt management program will also impact your credit however, because most people who sign up for a DCP already have bruised credit, this isn’t a major factor.
When you sign up for a DCP, your debts will have an R7 rating, and then two years after you’ve completed the Program the debts, along with their R7 ratings, will be purged from your credit reports. However, many of our clients see a jump in their credit score as soon as they’ve completed their DCP.
When you complete a DCP with Credit Canada, we send you all the information and forms you need to update your credit file with the two credit bureaus Equifax and TransUnion. The process is simple and straightforward, and yields great results when it comes to our clients’ credit ratings and credit scores.
Cons Of Balance Transfer
- Transfers cant be made using cards from the same bank.
- Most cards charge a transfer fee between 3%-5% e.g., if youre transferring $5,000, it will cost between $150 and $250.
- Most transfers must be completed within 60 days from opening the account, or you miss out on the 0% APR.
- The low interest rate is for a limited time typically six to 18 months then the rate increases to somewhere near 24% on whatever balance remains.
- If you use the card for purchases, the 0% rate may not apply.
- Card issuers usually limit the amount that can be transferred to a percentage of total credit limit or specific dollar amount, and they include fees in the calculation.
- Can hurt credit score if cards that debt was transferred from continue to be used, upping debt and credit utilization amounts.
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It May Improve Your Payment History Long Term
Payment history makes up about 35% of your credit score. If you already have a solid track record of making on-time payments, debt consolidation may not affect this aspect of your credit score. But if consolidating your debts into a new loan at a lower interest rate will make it easier for you to make payments on time, then debt consolidation could help improve your credit score in the long run.
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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When Should I Think About Consolidating My Debt
If you have a thousand dollars on two credit cards, and are paying off your balances each month, debt consolidation probably isn’t worth it, Nitzche said.You should be carrying at least $5,000 in unsecured debt before considering it, according to Rossman.
To choose the right strategy, tally up your credit card balances and loans, factoring in the interest rates, minimum monthly payments and outstanding balances.
And be sure to compare interest rates, terms of the contract, penalties and other information from multiple lenders.
Have A Fixed Repayment Schedule
If you use a personal loan to pay off your debt, youll know exactly how much is due each month and when your very last payment will be. Pay only the minimum with a high interest credit card and it could be years before you pay it off in full.
Takeaway: By having a fixed repayment schedule, your payment and interest rate remain the same for the length of the loan, theres no unexpected fluctuation in your monthly debt payment.
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Personal Loan Vs Balance Transfer Credit Card: Which Should You Pick
Taking out a personal loan and transferring balances to an existing credit card account are both popular options for consolidating debt. But which is the better choice?
The answer really comes down to how much you owe, your available credit, and what interest rate you qualify for. For example, if you have multiple accounts and higher balances, taking out a $20,000 personal loan may be more cost-effective than transferring six different balances and paying credit card balance transfer fees each time.
How Debt Consolidation Loans Can Help Your Credit Score
While taking out a debt consolidation loan might initially lower your credit score, making on-time loan payments could help your credit in the long run.
Edited byAshley HarrisonUpdated October 13, 2021
Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.”
If youre struggling with debt, a debt consolidation loan or balance transfer card could be a good option. However, you might be wondering if debt consolidation will hurt your credit.
Heres what you should know about the impact of debt consolidation on your credit:
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How To Consolidate Debt In General
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Will A Debt Consolidation Loan Look Bad On Your Credit Report
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When trying to deal with debt, consolidating your credit cards and high-interest loans can help you save a lot of time and money. Debt consolidation is a great way to get out of debt and more often than not it can help save you from financial ruin. While getting out of debt can be life-changing, you need to consider how a debt consolidation loan will affect your credit.
Will it look bad on your ? Will it affect your ability to get the loan you need? And how do you go about consolidating your debt so that it wont negatively affect your credit rating? Well go over all of these questions below so that you can be as equipped as possible to finally tackle your debts.
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The Smartest Way To Consolidate Your Debt
The most efficient strategy to consolidate your debt starts with making a list of all of your current loans and credit cards. Include the total balance, interest rate, minimum monthly payment and total remaining payments.
Next, decide what kind of debt consolidation option youd like, whether thats a personal loan, home equity loan or balance transfer credit card. You should get quotes from multiple lenders and compare APRs, terms and total interest paid.
Make sure to apply for these loans and credit cards within a two-week span to avoid multiple hard inquiries on your credit report. Once you have all of your offers, you can compare them with this debt consolidation calculator to see which lender you should choose.