Having several debts can be a hard and stressful situation since you might have to pay different bills every month. In this regard, many people consider debt consolidation. Through this method, you can get a lower balance, plus everything will be an easier way to eliminate your debt. However, before you choose this option, you need to understand how it will impact your credit score.
When it comes to debt consolidation, there are several methods that you can use. Some people opt for balance transfers and debt management programs. But, we are going to focus on the most common method, debt consolidation loans. Only in extraordinary cases, people decide to cash out from their RRSP or access the penalty-free plans of this account. If you want to read more about this option, visit Alpine Credits.
Before we talk about these special loans, we are going to talk about what exactly is debt consolidation.
Debt Consolidation: What is it?
Debt consolidation is the process in which all your high-interest debts including credit cards and student loans will be combined into one. That way, you can get a lower interest rate and more affordable payments. Depending on your situation, one debt consolidation method might be better than the other. But, if you don’t know which way to take, the best thing you can do is talking to your bank or credit union. Usually, all creditors will be willing to offer you some type of debt consolidation since that increases their chances to collect the funds.
Even when debt consolidation sounds like the perfect plan, in reality, it is only recommended for people who have several high-interest debts, such as large loans. The reason is that debt consolidation can hurt your credit score. That’s why to help you decide, here are the pros and cons.
If you choose to get some type of debt consolidation, here are some benefits you could enjoy.
Lower Credit Utilization Ratio
Let´s say you choose a loan as your debt consolidation method. When the loan is approved, your overall credit will increase. This means the utilization ratio of that credit will reduce. Having a good CUR is very important since this can actually increase your credit scores and allow you to access credit card rewards.
Eliminating several debts
Even though choosing debt consolidation means you will create one more credit, in your report it won’t look like that. Instead, all the accounts that you consolidate will be considered to be paid in full. That means that future lenders can potentially see this debt consolidation process as a good thing.
Paying all your debts on time can have a positive impact on your credit score. That’s why when you choose debt consolidation, you need to make sure the bill is paid on time. Otherwise, it will only hurt your financial status.
As we have seen above, there are some factors about debt consolidation that can help your credit score, but that is not always the case.
When you get debt consolidation, you can be debt-free in a short period. However, once you get all your debts combined into one, you can’t keep your old habits. That means you will have to reduce the unnecessary things you purchase every month. But, for some people maintaining this is very hard and the reason why they end up drowning in debt once again.
This is the average age of all your credit accounts. When the age increases, this will benefit your credit score. When it comes to debt consolidation, during the process you will close the majority of your accounts. This will affect your credit score since the credit age will significantly reduce.
If you decide to apply for a debt consolidation loan, your lender will have to perform a hard credit check. This type of inquiry will affect your credit score for the short term. However, this is usually not a critical scenario since your score will increase once you start repaying your debts.
Debt Consolidation Loans
As we mentioned before, debt consolidation loans are the most common way for consolidating all your accounts. This is a kind of loan that offers better terms and a lower interest rate. Overall, getting a loan to consolidate your debts is a great option as long as you make sure it will benefit you.
If you have a good credit score, you can get these loans with your current bank or credit institution. But in case your credit score is already bad, the only thing you can do is looking for an alternative lender. That way, you can work as a team, to be debt-free in no time. Keep in mind that when choosing a lender, you need to check out if they are reputable.
Now let’s look at some of the positive impacts a debt consolidation can have on your credit score.
- You will have a better credit mix, which refers to the different credit accounts you have. This factor is crucial when it comes to your credit score. That means that if you only have credit cards at the moment, getting a loan will benefit you.
- When you get a loan, that will reduce the overall credit you are utilizing each month. This is something that will also have a positive impact on your credit score. A debt consolidation loan can only harm your credit score if you don’t take it seriously. That means that you can only use your freed-up credit cards for necessities. All your payments have to be on time, plus during this time, you should try not to acquire new debt such as loans or mortgages.
When should I get a debt consolidation loan?
From all the information in this article, we can say that a debt consolidation loan is a great option for everyone who has multiples debts with high interest rates. This also applies to the ones that owe more than $10,000. In these cases, a consolidation loan will improve their credit score rather than hurting it.