Debt consolidation happens when you take out a single loan which is large enough to pay off several or all of your existing debt. You use the loan to pay off your credit accounts, and then make repayments to the new lender.
Debt consolidation simplifies finances by allowing you to pay one single monthly repayment. It is most effective when you can secure interest rates that are lower than your existing rates, reducing the total amount that you will pay on your debts overall. It can also be used to reduce monthly repayments in the case that you cannot keep up.
Though debt consolidation may seem like an attractive option for those who are struggling with debt, many people are concerned with how this might affect their credit score. The truth is, a lot of it depends on what you do after consolidation.
Immediate effects of debt consolidation on your credit rating
There are many factors that affect your credit rating, including the amount of debt that you are in, the amount that you can borrow, your repayment history, recent credit and more.
When you first apply for debt consolidation, this will trigger a “hard” credit check, which will initially lower your overall credit score slightly. Your new debt consolidation loan will also appear as a new credit account, and this too will adversely affect your score.
Do not despair though. Your debt consolidation loan will be used to pay off several existing creditors in full, and this will have a very positive impact on your credit score.
Tip: Debt consolidation is best achieved using a personal loan or a loan against your line of equity. Borrowing on a low interest credit card to consolidate existing debt can be a bad idea. The interest rates can rise after introductory periods, and borrowing a large sum on one credit card can negatively affect your rating.
Long term effects of debt consolidation on your credit rating
Aside from the immediate positive and negative effects of taking out a debt consolidation loan, how you handle your finances in the future will be the main factor that determines its effect on your credit rating.
Missing repayments will reduce your rating, but making consistent repayments on time can help to fix your credit rating. As you make repayments, this will be added to your credit history. If a debt consolidation loan helps you to get back on top of your finances and get out of debt, then it will have a positive impact in the long run.
Keeping your old credit lines open is useful, as this will improve your utilisation rate, the ratio of the amount of debt you owe compared to the amount you can possibly borrow. A better utilisation rate will positively impact your credit rating, but only if you stay away from trouble by not borrowing on these lines, or at least making repayments quickly if you do.
All in all, it’s really all about how you manage your money, and whether you make regular repayments to reduce your debts. If used wisely, debt consolidation loans can improve your credit rating in the long run.
Contact Debt Negotiators today for professional financial advice and debt consolidation services.