Will debt consolidation help or damage your credit rating?

September 16, 2014

Debt Management

Debt ConsolidationFalling knee-deep in debt and then deciding to consolidate your debt reminds one of the clich? about rearranging the deck chairs on the Titanic! Hardly a day goes by when you don’t receive a “consolidate your debt!” offer in your mailbox. When you’re trying to get out of debt, combining your credit cards and other loans can help you save your money and time. But doing this during a market where your credit rating is extremely important for any kind of financial transaction is pretty risky. Debtors often wonder whether or not debt consolidation will help or damage their credit rating. Well, the answer depends on how you consolidate your debt and what you do thereafter.

The impact on your credit score with respect to different consolidation methods

Moving your high interest balances into a single instalment loan for purposes of consolidation might have a slight dip in your credit score. Have a look at different methods and their consequential impact on your score.

Debt consolidation loans: The most popular way to pay off credit card debt is getting a new loan to pay off other debts. With the pitch of lower interest rates and single monthly payments, this is certainly what most people think of while consolidating. But finding a loan with decent interest rates and repayment term can often be a challenging task, especially when your credit scores are a bit low due to the balances that you’re already carrying. However, it is certainly not impossible as there are peer-to-peer loans and loans from the credit union that can help you consolidate even with a moderate or a poor credit score.

Impact on your credit score: Consolidating your credit cards with high balances using an instalment loan with fixed monthly payments may actually benefit your credit score, especially when you use the proceeds of the loan to pay off credit cards that are nearing their limits. At the same time, the inquiry caused while taking out the new loan can also cause a short-term dip in your credit score and you shouldn’t be surprised if that happens with you.

Debt management plans: Though they’re often confused with debt consolidation, yet a DMP is much different and it is offered through credit counseling agencies. They don’t actually consolidate your debt (unlike the debt consolidation companies) but they make a “consolidated” payment to the counseling agency, which then disburses your payments among your creditors. Even though you’re making one or two payments in a month, the counseling agent doesn’t actually pay off your creditors. Still these programs are offered to you irrespective your credit scores. So, when you’re having trouble consolidating your debt due to poor score, you may get help of a credit counseling agency and sign up with a DMP.

Impact on your credit score: Here, you will be required to close down most, if not all of your credit card accounts while you’re on a DMP and this will definitely hurt your credit scores. On the other hand, FICO also ignores any kind of notation that you’re paying your debt through a credit counseling program. So, this will affect your score, but it may not be as bad as you may fear.

Paying down debt can have a drastic impact on your credit scores. According to the company behind calculating your credit scores, FICO, consumers with high scores (785 and above), tend to maintain low balances. Specifically, 2/3rds carry less than $8500 in non-mortgage debt and use an average of 7% of their available credit on their cards.

This means that repaying debt, whether by using a debt consolidation loan or by putting every penny towards your debt, often can turn up to be helpful to raise the consumer credit ratings in the long run. Always remember that moving around debt isn’t the goal. In fact, the goal is to pay off those balances in order to free up cash flow and also help build strong credit. Therefore, a debt consolidation loan, used rightly, can help you achieve your goal just a little faster..