Debt consolidation by combining several balances of debt into a new loan is likely to increase your long-term credit scores if you use it to pay off debts. However, you may see a decline in your credit ratings at first. That can be OK, as long as you make your payments on time and don't accumulate more debt. Consolidating your debt can lower your monthly payments, but it can also cause a temporary drop in your credit rating.
Two common methods of debt consolidation are obtaining a debt consolidation loan or a balance transfer card. Payment history represents approximately 35% of your credit score. If you already have a strong history of timely payments, debt consolidation may not affect this aspect of your credit rating. However, if consolidating your debts into a new loan with a lower interest rate will make it easier for you to make payments on time, debt consolidation could help improve your credit rating in the long term.
Most debt consolidation methods will temporarily lower your credit rating for a variety of reasons. For example, debt management plans ask you to stop using your credit cards. Canceling a card reduces the amount of credit you have available and your credit score. Debt consolidation will affect your credit rating, but how much and for how long will depend on the consolidation method you choose.
After completing the debt consolidation process, consider leaving your old credit accounts open, but with zero balances. Debt consolidation is a way to simplify your debt and give yourself a break to focus on other financial and life goals. Next, we look in more detail at the possible impact on your credit when consolidating debt with a personal loan or credit card with balance transfer, as well as other debt consolidation options. Keep in mind that it's generally not a good idea to replace unsecured debt (such as credit card debt) with secured debt (such as a mortgage or car loan), as you could lose your house or vehicle if you can't pay.
However, this approach isn't without its drawbacks, so you should familiarize yourself with what debt consolidation entails and ways to minimize potential negative effects. Don't think that paying your credit card bills with a consolidation loan means you can use the cards recklessly again. While your credit rating may drop temporarily, managing your debt and making timely payments will help you improve your rating. If you want a personal loan or balance transfer card, compare interest rates, fees and payment terms at different banks and credit unions to find the best option for your needs.
A debt management plan consolidates debt with little immediate negative impact on credit and a possible long-term positive impact. The most common are debt management plans, personal loans and credit card balance transfers, but you can also consider a home equity loan or line of credit (HELOC) or apply for a 401 (k) loan. If you open a new credit account as part of your debt consolidation plan, whether it's a new credit card with balance transfer or a new personal loan, the average age of the accounts will decrease and your credit score may drop. To calculate how consolidation will affect your score, check out WalletHub's free credit rating simulator.
If you're having trouble paying bills or want to pay off your debts faster, debt consolidation could be a solution...