Did you like many others believe that debt consolidation loans are something to be avoided? Well, these loans are a great option if used wisely, especially when it comes to your credit score.
Debt consolidation loan – one of the most popular form of debt consolidation should be high on your list of feasible choices if you have a great deal of outstanding debt and are thinking about consolidating your debts. A debt consolidation loan does not forgive your debt or reduce it, but it helps you manage your debt by rolling it all into a single monthly payment. One of the biggest advantages of the debt consolidation loan is that it comes with a comparatively lower rate of interest than that of your other debts.
Credit reporting agencies issue a credit score to each consumer based on his or her credit history. The lending institutions utilize these credit scores to determine your level of risk for a loan or a credit line. A debt consolidation loan also affects your credit score. Let’s see how:
How It Can Help Your Credit Score
- One of the major factors which can help boost your credit score, is on-time payments on your credit accounts and your debt consolidation loans every month.
- You have had only revolving credit accounts like credit cards and consolidated them with an installment loan like a personal loan. So, if you have more than one type of credit account, it can help your credit score a bit.
- Consolidation loan helps you pay off credit card balances which are higher than 30% of the credit limit on that card. Credit utilization which is the amount used compared to your limit, also has a big effect on your credit score.
- Since you have addressed the issues which had led to your original debt, you have a good shot at paying off your debt and keeping it down.
How It Can Hurt Your Credit Score
- Like on-time payments can help your score, delayed payments can hurt your credit score. So, if you start missing out on your payments or make late payments on your debt consolidation loan, your credit score will see a decline.
- Closing a credit account may seem like a good idea so that you are not tempted to use it. However, it may have a negative impact on your credit score. It lowers the amount of your available credit, thus changing your debt into limit ration. So, if at all you must close some of your credit accounts, close the recent ones only. Because, your old credit accounts carry more of your credit history.
- Once you have credit room on your cards, you may again run up your balances. So, the gain achieved from cutting down your credit utilization is erased as soon as your balances rise. This can hurt your credit score.
- Each application for balance-transfer cards or personal loans for which you cannot qualify for, reduces your credit score by a few points. Too many of such credit applications can at once bring down your credit score because it may be perceived as an indication of financial instability.
A debt consolidation loan will definitely affect your credit score ranking positively in the long term if you use it responsibly and appropriately. It should be kept in mind that one of the greatest pitfalls when it comes to debt consolidation loans is the risk of landing up in a new debt before you pay off the one on the consolidated loan. So, when you clear off the debt on your credit cards with a debt consolidation loan, avoid the temptation to use the newly freed up credit limits.
Shiv Nanda is a financial analyst who currently lives in Bangalore and works with MoneyTap, India’s first app-based credit-line. Shiv is a true finance geek, and his friends love that. They always rely on him for advice on their investment choices, budgeting skills, personal financial matters and when they want to get a loan. He has made it his life’s mission to help and educate people on various financial topics, so email him your questions at [email protected]