Is Debt Consolidation Bad for Your Credit?


 It is inevitable that difficult times will arise. With the frequent changes in the economy, we see people struggling to pay their payments and falling into debt. And if you're in debt, you're probably looking for a specific strategy to get out sooner.

You may have heard about debt consolidation in your search for a solution. However, before making this decision, it's critical to understand how it works and how it affects your credit score.

Find out everything you need to know right here.

WHAT IS DEBT CONSOLIDATION AND HOW DOES IT WORK?

Debt consolidation (not to be confused with Debt Settlement) is the practice of consolidating various, high-interest debts into a single monthly payment and repaying them with a personal loan.

If the working connection is good, most people apply for debt consolidation through their credit unions, credit card providers, or banks. If these institutions refuse to sanction such loans, you may want to look into lenders and private mortgage firms.

HOW DOES CREDIT SCORE AFFECT DEBT CONSOLIDATION?

Debt consolidation can have a positive or negative impact on your credit score. Before moving forward with your plan, it is critical to examine these factors.

HARD INQUIRIES ARE THE END RESULT

A hard inquiry is made on your credit when you seek for a loan to pay off your debts. Hard enquiries are made to determine your creditworthiness - your likelihood of repaying the loan if it is authorized. Your credit score will be lowered by 5 points if you have a hard inquiry.

If you apply for debt consolidation from different lenders, your credit information may be subject to hard inquiries. But don't be concerned. As long as the hard queries are made within 14 to 45 days of each other, they will not have a compounding effect on your credit score. As a result, when your credit bureaus calculate your credit score, these requests will be combined into one.

When applying for a loan, keep in mind that aggressive inquiries aren't required. Examine a lender's website or booklet to discover if you qualify for a loan without performing hard inquiry checks. Some lenders need a soft inquiry (also known as a soft pull), which has no effect on your credit score.

THE WAY YOU USE YOUR CREDIT WILL CHANGE

Your credit usage ratio is also important to financial institutions and lenders. This ratio refers to how much of your available credit you use at any given moment, and it accounts for around 30% of your FICO score.

Your credit score will drop a few points if your credit use ratio after debt consolidation is greater than 10%. If you pay off the sum with a personal loan, the percentage will decrease, and your credit score will rise.

YOUR ACCOUNTS MAY BE TEMPTED TO BE CLOSED

After transferring a balance, people who go through the debt consolidation process are more likely to close their former accounts. Hold that thought if you're thinking about it. Your credit score is made up of around 15% of the average age of all your accounts. As a result, older accounts contribute to higher credit scores.

Opening a new credit account and canceling an existing one might reduce the average age of your credit accounts and boost the credit utilization ratio. Your credit score will suffer as a result of these acts. For the benefit of your credit report, we recommend preserving your old accounts (even if they have no balances) following a debt consolidation.

IT MAKES YOUR PAYMENT HISTORY BETTER.

Your credit score will not be harmed if you have a track record of paying off your debts on time. It will, without a doubt, improve in the long run. Your payment history accounts for around 35% of your credit score.

As a result, consolidating your loans into a single loan with reduced interest rates will enhance your credit score significantly.

DEBT CONSOLIDATION PROS AND CONS

Debt consolidation has a number of advantages and disadvantages. Let's have a look at them:

Pros:

  • Your finances will be more organized. It is easier to pay off various obligations when they are combined into a single loan. There are no multiple payments or interest rates to worry about. It also lowers the likelihood of late payments.
  • Payments are lower each month. You will have reduced debt repayments after merging your debts because your payment plan will be spread out over a longer period of time.
  • Have a set payback schedule in place. When you use a loan to consolidate your debts, you'll know how much you owe each month and when your last payment is due. You won't have to worry about your payments increasing or decreasing at unpredictable intervals.
  • Improve your credit rating. Consolidating your debts will result in hard inquiries, which will have an influence on your credit score. However, if you pay off your loan on time, your credit score will rise. Your payment history accounts for 35% of your credit score, so paying on time will help you boost your score over time.

Cons:

  • Added expenses. Bank transfer fees, closing costs, origination fees, and annual fees are all included in some debt consolidation loans.
  • A rise in interest rates is a possibility. You may be left repaying your bills at a higher rate if your credit score isn't good enough to get lenders to offer you affordable rates.
  • You run the danger of falling behind on payments. When you default on a debt consolidation loan, your credit score suffers significantly. You also run the risk of incurring additional charges.
  • It won't help you break your bad financial habits. Even if you consolidate your debts, it won't cure the underlying financial issues that led to your current situation. As a result, it is critical to engage in prudent financial behavior in order to keep overdue bills to a minimum.

HOW TO MERGE CREDIT CARDS WITHOUT HARMING YOUR CREDIT SCORE

If you want to combine your bills without affecting your credit score, consider the following options:

SEEK THE ADVICE OF A NONPROFIT CREDIT COUNSELING AGENCY.

A nonprofit credit counseling firm can help you set up a debt management strategy. They can assist you in developing plans to address your problems, budgeting your funds, and working with your lenders to set up payments. Instead of paying many lenders, you'd just pay a monthly fee to the agency, which would then pay your lenders.

TRANSFER OF CREDIT CARD BALANCE

Another option is to transfer your entire existing credit amount to a new credit card with a 0% annual percentage rate (APR). It makes it easier to pay off all of your debts without paying interest.

You'll almost certainly have to pay a balance transfer fee of up to 5%, but it's much better than taking out a personal loan.

REVISION OF THE BUDGET

You can still pay off your debts on your own if you make a budget that works for you. Reduce wasteful spending and put the money toward your repayment arrangements.

TAKE A LOAN FROM YOUR 401(K)

Taking out a 401(k) loan will not affect your credit score. As a result, these loans have no bearing on your credit scores.

TIPS ON HOW TO USE A CONSOLIDATED PLAN TO AVOID HARMING YOUR CREDIT SCORE

There are a few things you should keep in mind while repaying a debt consolidation loan to keep your credit score from plummeting. They are as follows:

DURING THIS TIME, AVOID TAKING ANOTHER LOAN

While repaying a consolidated loan to a lender, you should not apply for another loan. It would necessitate a hard investigation, which would lower your credit score and make you less creditworthy.

EXISTING CREDIT ACCOUNTS SHOULD NOT BE CLOSED

Keep your older accounts open because their average age accounts for around 15% of your credit score.

KEEP A GOOD FINANCIAL HABIT

Maintaining good financial habits helps ensure that your consolidated debts loan is repaid on time.

FINAL THOUGHTS ON THE BENEFITS AND DISADVANTAGES OF CONSOLIDATING LOANS

Debt consolidation can help you pay off your bills more quickly. You won't have to worry about different interest rates or payment schedules. It also aids in better budgeting prior to payment day and, in the long run, improves your credit scores.

Debt consolidation, on the other hand, comes with hard inquiries, additional costs, low credit ratings if payments are missed, and higher interest rates if you already have a bad credit score. If you decide to go ahead with the loan, it is essential that you take important efforts to pay it off quickly. Are you wanting to enhance your credit after paying off your debt? The Phenix Group can provide you with a free consultation.

Related Articles:

https://thephenixgroup.com/credit-repair

https://thephenixgroup.com/how-do-credit-cards-work

https://thephenixgroup.com/collections-and-your-credit-score-we-answer-the-top-questions


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