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 credit report? Will it affect your ability to get the loan you need? And how do you go about consolidating your debt so that it won’t negatively affect your credit rating? We’ll go over all of these questions below so that you can be as equipped as possible to finally tackle your debts.
Debt Consolidation Loans
The debt consolidation loan is probably the most popular form of debt consolidation. Simply put, you get a new loan that has better terms and a lower interest rate, to pay off your other debts. If you’re currently thinking about consolidating your debts this option is probably high on your list of viable choices.
A debt consolidation loan can be an extremely useful tool, just make sure you’re getting one that is actually going to help your debt situation, and not hurt it. Your best bet is to go with an alternative lender, especially if your credit is already less than great. Banks typically only want to lend to people with a high credit score. An Alternative lender will work with you to help you get back on track; just make sure you choose a reputable lender.
How Will a Debt Consolidation Loan Affect Your Credit?
Consolidating your maxed-out credit cards with an installment loan (a debt consolidation loan) will more than likely help your credit score. Having a variety of different types of credit accounts will help improve your credit score and paying off credit card debt is always a good idea. Just remember that applying for a new loan may also cause a short-term dip in your credit score, don’t be worried if this happens.
If you want to consolidate your debts on your own then you might want to consider a balance transfer. This is where you transfer the balance from your high-interest credit card to a card that has a lower interest rate. While this can work it is extremely important that you find a credit card that has a lower interest rate and affordable balance transfer fees. A balance transfer is almost never free so if the fees associated with it are high, it might not be worth it. Also, make sure that the low-interest rate you thought you were getting doesn’t end after a short introductory period.
Learn how to consolidate your credit card debts.
How Will it Affect Your Credit?
There are a few issues that you need to take into consideration before you decide that a balance transfer is a good idea:
- First, cancelling a credit account that has been open for a long period of time is not good for your credit score.
- Second, using up all your available credit is also not a good idea.
- Thirdly, balance transfers can be expensive.
If you’re able to find a 0% credit card and you’re able to both save money because of a lower interest rate and pay off your debts faster, a balance transfer can work.
Debt Management Programs
If you’re having trouble getting a debt consolidation loan because of your low credit score then you should consider entering a debt management program. You’ll work with a credit counsellor who will negotiate with your creditors to reduce your interest rates and payment amounts. You’re still paying back your debt and you’re technically not consolidating your debt, but it’s another great form of debt relief.
One of the best things about a debt management program is that your credit score isn’t taken into consideration so if you have an extremely low score you can still get the help you need and want.
How Will it Affect Your Credit?
This completely depends on where you are financially before you enter a debt management program. But you’ll also be given an R7 credit rating that will last for the following 3 years. An R7 credit rating will show up on your report as “making regular payments through a special arrangement to settle your debts”.
Debt Consolidation: Positive Effects on Credit
While every debt consolidation option has its own unique effect on your credit rating there are a few positive effects you can look forward too:
- Reduces Credit Utilization Ratio: By opening a new credit account (debt consolidation loan), your overall available credit will increase. This, in turn, will reduce your credit utilization ratio which will positively affect your credit.
- Paid Debts: While debt consolidation does create a new credit account on your credit report it will also look like one or more have been paid off. Potential new lenders will consider your consolidated accounts to be paid in full.
- Better Payment History: Since you’re on a mission to become debt free make sure you make timely payments on your debt consolidation loan. Though it may take some time, full on-time payments on your debt consolidation loan will positively affect your payment history which has the biggest impact on your credit score.
Debt Consolidation: Negative Effects on Credit
While every debt consolidation option has its own unique effect on your credit rating there are a few negative effects you should prepare yourself for:
- Debt Consolidation Can’t Help Bad Habits: How you treat your credit after you’ve consolidated your debts is extremely important. If you simply fall back into old habits you’ll end up hurting your credit score again.
- Lower Credit Age: While it might seem like a good idea to close a credit account to prevent yourself from using it, this will, in fact, hurt your credit score. One of the factors that affect your credit score is the average age of your credit accounts. Closing old ones and open new ones will, unfortunately, lower your average credit account age which will negatively impact your credit.
- Hard Inquiries: When applying for a debt consolidation loan, lenders will perform a hard credit check which results in a short-term dip to your credit. This usually isn’t a big deal and is quickly regained as you pay back your debts.
If you handle debt consolidation appropriately and responsibly, the long-term effect on your credit score and report should be more positive than negative. Trying to cut corners or ignoring the issues at hand will end up doing more harm than good. We want you to remember that the main goal of debt consolidation is to pay back your debts and to take back control of your personal finances. In the end, your credit report should be on its way to looking better than it did before you decided to consolidate your debts.
Looking For Debt Management Solutions?
Besides debt consolidation, there are a few other tools and options you can use to manage your debts. You can try tracking your expenses with budgeting apps, creating a budgeting plan with a credit counsellor, or in more extreme cases file for a consumer proposal or bankruptcy.
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