If you’re considering debt consolidation, one of the first questions you might have is how will it affect your credit score.
The simple answer is, it depends on how you use the consolidation, and what you do afterwards.
Read on to learn how to make debt consolidation work in your favour to repay your debts sooner, and improve your credit also.
The debt consolidation rundown
Rolling your multiple current debts into one larger debt is the basic premise of debt consolidation.
Whether you bring your credit card balances and personal loans into your mortgage, transfer all credit card balances onto a new card, or take out a new loan to consolidate your debts, the goal is to make repayments simpler, your interest rate lower and meet your financial goals sooner.
Paying off old debts is good
When you consolidate your debts, this new line of credit pays off your old debts, and you are then responsible for repaying the new, bigger debt.
Your credit report shows that those lingering debts are marked as paid in full, which is great for your credit score. As long as you are meeting your new repayments consistently, credit agencies see that you’re taking responsibility and working to resolve your debt.
This is especially the case for credit cards. Part of your credit score is derived from your credit utilisation.
This is the ratio between the amount of credit available to you, and the balance. So if you pay off your credit card balance(s) and – this is key – don’t rack up new debt, your ratio will decrease and your credit score will go up.
Get into good financial habits
Depending on how you came to need debt consolidation, will help you choose what the best next step is going to be for your situation.
If you aren’t likely to reach out for that newly cleared credit card, keep the credit accounts you have just paid off, open. This improves your credit utilisation and your score will reflect your discipline.
However, if you know that you’re likely to be tempted to accrue more debt if you have a credit card available to you, close the account so that you don’t end up in an even worse financial state.
Your credit score may dip temporarily, but over time will improve as you keep making repayments on your consolidated debt.
Consistent, on time repayments is essential
The takeaway message is that making your new repayments consistently on time is crucial for debt consolidation to improve your financial situation and credit score.
The beauty of debt consolidation is that it makes repayments more manageable: you only have one periodic repayment (set it up to coincide with your pay day and you won’t even notice it), one creditor, one set of fees and one interest rate.
You can easily track your decreasing outstanding balance, and plan towards your loan term end date.
Seeking free financial advice is a great first step if you think that debt consolidation may help you.