How Does Debt Consolidation Hurt Your Credit

You’re ready to tackle your debts, and you are probably wondering, how does debt consolidation hurt your credit? The answer varies according to the method and approach you use to actually consolidate your debt and pay it off.

Initially you may see a drop in your credit as you get organized to pay off your debt, but then as the balances decrease and your monthly payments increase, you will hopefully see a big boost to your credit quickly. If not right away, then down the road your efforts will be reflected positively in your credit score.

Ways that Debt Consolidation Can Affect Your Credit

Do how does debt consolidation affect your credit? In several ways and with different levels of impact. Here are the various ways you expect to see your credit affected by debt consolidation.

• New credit applications hitting your credit. Every loan or credit card you apply to shows up on your credit score. When you apply for a debt consolidation loan, you can count on the inquiry showing up on your credit score. The more inquiries, the more impact on your score. An inquiry lowers you score a few points, but it should come back up in fairly short order.
• Shorten the length of time you’ve had credit accounts open. The longer you’ve had credit available, the higher your score. The average lifespan of your credit can be affected two ways when figuring out how does debt consolidation affect your credit. First, any new debt consolidation loans will shorten the overall average of open cards because they have no history. Second, closing accounts as you settle them or pay them off will shorten the overall lifespan of your average because you are closing some of your oldest accounts.
• Lowering your credit utilization. Using all of your available credit is a bad idea. The goal is to have lots of credit available every month, showing that you’re using credit wisely and not running up balances on your cards. As you pay down cards and eventually clear the entire balance, your credit utilization ration will drop and your credit score will go up accordingly. This is especially true if you leave cards open after you’ve paid them off. However, while some empty cards may help your score, opening a new credit card and transferring balances to that one and filling it up may negatively impact your score as you have now effectively maxed out that card. Fortunately as you pay it down your ratio will again decrease and you’ll be ahead again.
• Closing credit cards. If you sign up for a debt management plan or you settled your debts, you may be told you must close your credit cards. When you close the credit card accounts, you are reducing the amount of overall debt you have, but you are also reducing the amount of credit you have available. Less available credit means a lower credit score.
• Debt forgiveness. When figuring out how does debt consolidation hurt your credit score, a concept like debt forgiveness might sound ideal. The truth is, however, that debt forgiveness can dramatically harm your credit score. Debt forgiveness is essentially settling with your credit card company to pay less than the original amount of debt you owed.The company reports this settlement number to the credit bureaus and to the IRS. Settled debt is reported as “paid settled” which will remain on your credit report for a full seven years. While not as bad as being removed during bankruptcy, being marked as “paid settled” is very negative as well.
• Late payments. If you make late payments, or if the debt management program you choose winds up making late payments as you transition into their program, those late payments will be reflected very negatively in your credit report. Late payments are reported to the credit bureaus, and those late payments can stay on your credit report for years, negatively impacting your credit score.

The Two Most Popular Debt Consolidation Methods and Credit Impacts

To examine the question of how does debt consolidation hurt your credit score, we look at the credit impacts the two most popular debt consolidation methods present.

Debt consolidation with balance transfers

When you open a new credit card with a low introductory rate, you can expect a new low payment, a smaller overall payment and no prepayment penalty. You can also expect to see the following negative impacts:

• A drop in your credit score due to high credit utilization
• A possible increase of debt and payments if you fail to finish paying off the debt in the introductory period.

Consolidation with a personal loan

A personal loan will likely have a lower APR for the life of the loan than a credit card and may need a lower credit score to be approved. A personal loan may improve your credit mix, which will raise your credit score and it will improve your score when you pay off smaller cards with your loan proceeds, but leave the accounts open. How does debt consolidation hurt your credit score with a personal loan?

• An increase in debt if you charge items on the newly emptied cards.
• Late payments may occur as you wait for loan proceeds to pay off cards.
• Paying more for the debt due to prepayment penalties

Getting on top of your debt is definitely a good thing, and making smart decisions about your debt consolidation options is imperative if you want to keep your credit score in good shape. Whatever method you chose, stay on top of your loans and make payments on time. Then you’ll never have to wonder, how does debt consolidation hurt your credit?