How Debt Consolidation Affects Credit Score

The purpose of debt consolidation is to facilitate the repayment of existing debts, however, it affects credit scores. How? Well, it depends on how you manage the loan consolidation.

If you feel as though you’ve lost your footing when it comes to handling your finances and managing debt, then it makes sense that you’re considering applying for debt consolidation programs. After all, the purpose of programs such as these is to help consumers like you to get out of debt. Through consolidation, you combine all of your accounts and balances to enable you to make a single monthly payment, often with reduced interest rates, so you can get back on your feet.

Sounds good, no? Take note that you will see a change in your credit score, though.

Overview of Loan Consolidation

Debt consolidation involves taking out a new line of credit to pay off your outstanding accounts. After you’ve paid off all your existing debts, you will then only need to pay the new line of credit. This type of debt relief program provides consumers with the benefit of dealing with a single payment on a monthly basis, as opposed to keeping up with multiple payment schedules and interest rates each month. Knowing exactly how much you need to pay every month gives you peace of mind and will also allow you to budget your funds more efficiently.

Debt consolidation loans will also likely save you money, since these usually have lower interest rates than your credit cards are charging you.

Risks Involved

Debt consolidation isn’t applicable for all types of financial woes, and will only work if you manage it correctly. In fact, even making sure you are doing the right thing with your loan consolidation repayments can temporarily hurt your credit score. Since the amount of credit you have and the percentage of that credit you are using are important elements of your credit score, closing off your accounts after you pay off debt will affect your credit score adversely since this will reduce the amount of credit that you have.

I know what you are probably thinking – “Well, I can just leave them open after I repay the debt.”  That’s certainly a viable option. However, you are opening yourself up to temptation and no matter how good your intentions are you may end up using them again. Not only will you be paying for your debt consolidation loan, you will also need to pay the cards you charged again, defeating the purpose of obtaining this debt relief program to get out of debt. If you must keep some accounts open, choose ones that are older since they carry more of your credit history than recently opened accounts.

You need to be fully committed to a debt consolidation program for it to work. It’s a no-brainer: if you start missing payments or making late payments on your loan consolidation, your credit score will decline.