Consolidating Debts without Ruining Your Credit

When you have a lot of debts, consolidating them down to one, easy to manage repayment makes a lot of sense. It simplifies your bookkeeping, can reduce the overall interest rate you are paying, and can help you pay off your debts faster. However, consolidating your debts can have a negative impact on your credit score.

Fortunately, there are ways to consolidate your debts without ruining your credit.

How can you Consolidate Your Debt?

There are several major methods to consolidate your debts, each with their own positives and negatives. The first is a debt settlement. In this form of consolidation you make one payment to a debt settlement firm that then distributes the amount among your creditors. You don’t actually consolidate any of your debts; all you do is consolidate your payments into one cheque.

Another method is a debt consolidation loan. Essentially, you go to a lender and take out one loan that pays all of your other debts in full. Those debts are then shown as “Paid in Full” on your credit report with a zero balance. Collateral is usually required in this form of loan, but not always.

A third method is via a Debt Management Plan. In a Debt Management Plan, a credit counselor assigned to you will negotiate with your creditors to help make your monthly payments manageable and more affordable. Your credit account will be frozen for a period of time, which does not allow you to open any new accounts or make new purchases.

Finally, you can also choose to use balance transfer cards. This form of debt consolidation sets your interest rates to 0% for a few months, allowing you to aggressively pay off your debts without worrying about high finance charges.

How does Debt Consolidation Affect Your Credit Score?

In the first method, debt settlement, the accounts will be shown as “settled” in your credit report, which hurts your credit history and your credit scores. A consolidation loan will hurt your credit score in the initial enquiry, but can actually improve it provided you make on-time payments.

A Debt Management Plan does not affect your credit score negatively in any way, and can also help to improve it if payments are made on time. The balance transfer cards method will make your credit dip slightly, but will improve your credit utilization rate and in effect, your credit score.

When Should You Consolidate Debt

The best way to consolidate your debt is with either a Debt Management Plan, or a balance transfer card, as they have the lowest negative effect on your credit, and can potentially lead to positive effects. However, you should only consolidate your debts when you have the means to pay them, as consolidating your loans and then not paying them on time will make things worse than when you started.

Every situation is unique, and you should of course speak to a trusted financial advisor before making any decisions.

 


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