Debt consolidation can be a great way to reduce your monthly payments and get out of debt faster, but it can also have a negative impact on your credit score. When you consolidate your debt, your credit is checked, which can lower your credit rating. Consolidating multiple accounts into a single loan can also lower the credit utilization rate, which can also hurt your rating. However, in the long run, debt consolidation can positively affect your credit, especially when you make timely payments. Two common approaches to debt consolidation are obtaining a debt consolidation loan or a balance transfer card.
A debt management plan consolidates debt with little immediate negative impact on credit and a possible positive long-term impact. It doesn't involve taking out a loan or increasing credit, and your credit score is not a factor in eligibility. You make a fixed monthly payment to a nonprofit debt management company, usually for three to five years. The company distributes the money to its lenders.
The plan is noted on your credit report, but it closes once it is completed. Closing credit card accounts may slightly lower your credit score, but paying bills on time will improve your credit score. Debt management plans come with a monthly administrative fee. When you apply for a debt consolidation loan (or any type of loan), the lender must perform a solid credit consultation, which is recorded in your credit report. Regardless of which method you choose, the most important factor in how debt consolidation affects your credit is how you treat the credit you have.
If you take out a loan to pay off your debt and then accumulate it again, you're in a much worse situation than you would have been if you hadn't done anything. 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. In addition, a debt consolidation loan has an additional benefit, as consumers go from making many payments to many creditors a month to making one payment to a creditor each month. Any savings gained from consolidating your debt seem to disappear quickly in your daily expenses. Debt consolidation loans can reduce monthly payments and provide significant relief to consumers who are struggling under a heavy debt burden. But if consumers aren't disciplined and don't change their spending habits, a debt consolidation loan could put them in a worse situation.
Working with a reputable credit counselor is a good way to explore debt relief options and decide how best to consolidate debt for your financial situation. They also have calculators that can help you decide if debt consolidation makes sense based on your debt obligations. After all, debt consolidation simply makes it easier to deal with your debt; it doesn't reduce what you owe or address the underlying issues that caused you to go into debt in the first place.