Are you stuck with multiple debts and wondering if consolidating them all is the best idea? Do you want to know how consolidating your debts can affect your credit score? Merging all your credits into a singular debt can be an excellent way to ease the debt burden.
How you handle loans and debt repayments—often— impacts your credit score.
But before you consider the debt consolidation strategy, it is crucial to learn its impacts on your credit score.
Fact: $15.58 trillion! That’s the total American consumer debt as of quarter four, 2021. And this means that you’re not the only one looking for the best debt management strategies.
Keep reading this article to understand how debt consolidation affects your credit score.
What Does Debt Consolidation Mean?
Life happens, and before knowing it, you have student loans, credit card debts, personal loans, mortgages, auto loans, among other debts to settle.
Paying off these debts —individually— can strain and hurt your finances pretty bad. At this point, you would appreciate it if someone lends you a lump sum amount to pay them all so that you can focus on a single debt.
And that is where debt consolidation comes—you approach a new lender to help offset your current debt so you can pay them instead.
Debt consolidation is an excellent way to streamline your finances, expedite debt repayment, and enjoy low-interest rates.
You can consolidate your debt using a personal loan, balance transfer card, retirement savings, or home equity loan/home equity line of credit.
Does Debt Consolidation Affect Your Credit Score?
Debt consolidation is an ideal option when you’re drowning in debts. However, merging your debt into one bigger loan could affect your credit score. Understanding the relationship between debt consolidation and credit score is crucial, so you know what you’re getting yourself into when using this option.
Debt Consolidation Can Improve Your Loan Payment History.
Loan payment history is one of the crucial factors contributing to your credit score, and it accounts for 35% of your FICO® rating.
Debt consolidation can attract lower interest rates, making it easy to pay it off. Paying this new loan consistently on time will boost your payment history.
A good payment history tells lenders that you can pay off debt on time.
Ultimately, it will improve your credit score.
It might take some time before your payment history shows an impact on your credit score.
Hard Credit Check Inquiries Can Affect Your Credit Score.
Consolidating your debt means that you have to get a new line of credit or loan. And this is the trickiest part because your lender will have to do a hard pull to check your creditworthiness.
Typically, your lender will want to do a background check to see if you can pay back the loan on time.
And the credit file has all information on your financial management that helps lenders decide whether to lend you money or not.
Every time you make a hard inquiry, it eats away a few points on your current credit score. Typically, the more hard credit check you perform, it comes off as a sign that you’re looking to take more loans.
But not to fret, though, because hard inquiries can negatively affect your credit score for a short period before it changes.
Debt Consolidation Can Affect Your Credit Utilization Rate.
Your credit utilization rate is another significant parameter that creditors pay attention to when weighing up your creditworthiness.
But, what does credit utilization ratio/rate mean? It is the percentage rate of your loan divided by the loan limit.
The credit utilization rate accounts for 30% of your credit score.
Now, if you have a higher credit utilization rate, it means that you’re overspending on your available credit—credit scoring models don’t like that, and it will lower your credit score.
On a positive note, if you have a low credit utilization rate, it means that you’re doing great managing your finances.
So, how does debt consolidation impact your credit utilization rate?
Notably, consolidating your credit card debts to one credit account can increase your utilization ratio plunging your credit score.
On the other hand, paying off your credit card debts with a personal loan will lower your credit utilization rate—probably to zero—hence boosting your credit score.
Failure to Make Payment on Time Can Hurt Your Credit Score.
Debt consolidation is far from being debt-free! And this means that you might have one colossal payment to make every month.
Depending on the consolidation structure you choose, you might end up with a more expensive loan than the ones you currently have.
If you miss your payment, it can negatively affect your credit score.
Before you take a debt consolidation loan, it is best to assess if you can afford it. Preferably, consider it if the interest rate offered is lower than the current ones you’re paying.
Also, it is crucial to know if the loan comes with extra costs like origination fees to avoid paying more money and ultimately hurting your finances.
A New Credit Account Can Lower The Average Age of Your Accounts.
Debt consolidation might require you to open a new account, which can impact the average age of your total credit accounts. The low average age of accounts can lower your credit score.
You should note that the average account’s age accounts for 15% of your credit score.
Again if your other credit scoring parameters are excellent, the average age of your accounts may not cause a significant hit on your overall credit score.
Can I Still Use My Credit Card After Debt Consolidation?
Once you consolidate your debt, keeping those credit cards open but maintaining zero balances is beneficial.
The last thing is to plunge yourself into another cycle of debts. The reason to keep your accounts open is that it benefits your credit score.
What is The Most Brilliant Way to Consolidate Debt?
There are excellent options to consolidate your credit card.
You can consider a personal loan to consolidate your credit card debt. An unsecured loan offers a fixed interest rate which means that your monthly balances will never change.
Shop for a personal loan with lower interest rates than your credit cards.
Another option to consolidate your debt is to use a 0% APR balance transfer credit card. This strategy is best for your high-interest rate credit cards.
With a zero balance transfer card, you can enjoy a grace period of zero interest rates, making it easy to offset your hefty loans.
Another smart way to consolidate debt is to consider a home equity loan. Consolidating your debts with home equity loans can give you more repayment time which means lower interest rates.
Debt consolidation can impact your credit score positively or negatively. Consider a debt consolidation program if it offers more benefits and relieves debt stress.
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