Can Debt Consolidation Hurt Your Credit?
Whether you take out a debt consolidation loan or opt for a debt management plan, making your payments on time will be key.
When you’re trying to get out of debt, it’s important to consider many different options. Unfortunately, much like with losing weight or starting a zoo, there isn’t some miraculous step to take that will instantly get you out of debt overnight. There is no magic diet, there is no mail-order zoo kit, and there is no company or product that will just instantly erase your debt.
But there are a lot of companies that offer ways to help fix your debt over longer periods of time. Obviously, anything that sounds too good to be true probably is, but some programs are worthy of consideration. One of those programs is debt consolidation. But how does it work, and what will it do to your credit?
A credit counselor can help consolidate your debt.
When considering debt consolidation, you have to consider whether you’re looking for a debt management plan or a debt consolidation loan.
“Our finances are typically referred to as ‘personal’ finances for a reason,” explained Carlos Perez, Director of Counseling Services at DebtWave Credit Counseling, Inc (@debtwave). “Our relationship with money, debt, credit cards, saving, etc. is largely a result of how we grew up, our values, education, and our experience with money.
“Just like there are many ways to spend money and get into debt, there are a few different options for those looking to pay off their debts. One of which is debt consolidation. At DebtWave Credit Counseling, Inc., we are a nonprofit credit counseling agency working to help our clients get out of debt in three to five years or less.
“To do this, we work with creditors to lower the interest rates and monthly payments for our clients. When an individual recognizes they are over their head in debt and give us a call, we share seven other options for getting out of debt. We do this because there is a chance that based on their lifestyle, needs, etc., they may not be an ideal candidate for enrolling in a debt management plan.
“One of the options for getting out of debt that we share with our clients is debt consolidation, or obtaining an unsecured personal loan.”
You could also take out a debt consolidation loan.
On a basic level, getting a debt consolidation loan means taking out a new personal loan to pay off your current debts. This leaves you with only one loan to pay off, hopefully with lower interest.
“Just like there are pros and cons to a debt management plan, there are pros and cons for obtaining a personal loan,” advised Perez. “For example, instead of having maybe three or four different credit card payments, someone who consolidated their debt via a personal loan may now have one monthly payment. There’s also a chance they were able to negotiate a lower APR or lower monthly payment.
“However there are also some serious cons with debt consolidation. For starters, to get a loan, one needs to have good credit. If you’re in credit card debt, you still may be able to qualify for a loan, but you’ll likely have to pay a higher interest rate and a higher monthly payment because your credit score is already lower due to the debt.”
So how will debt consolidation impact your credit?
It depends! As Perez pointed out, the terms of your debt consolidation loan can vary. And what those terms are can affect how well you’ll be able to keep up with payments and therefore how it might impact your credit.
“Debt consolidation can help or hurt a person’s credit,” attorney Marie Martin told us. “I think debt consolidation is a tool that can be effective if used wisely. The credit reporting agencies don’t give out a lot of information about how they calculate credit scores, and I think consumers make better financial decisions if they focus on how an additional debt will impact their overall quality of life rather than how or if it will change their credit score.
“I have found that many families that go through debt consolidation end up reusing the credit card balances they paid down to zero in the consolidation, so they end up with the consolidation loan and the credit card debt again as well. The amount that is consolidated seems to be the biggest factor in determining whether the process helps them get back on their feet or is the shovel that helps them dig a bigger financial hole for themselves. The larger the consolidation amount, the more likely it is to upset the family finances in the long run.”
With debt consolidation, making your payments is key.
“Typically, debt consolidation can both help or hurt your credit depending on how you use it. If you make the necessary monthly payments on time each month it will typically help your FICO credit score. However, if you are late on payments or if you are applying for several different loans then your FICO credit score could be hurt. Usually, debt consolidation can help with a lower interest rate so doing it is beneficial as long as necessary payments are being made on time each month.”
Much like any financial service, you’ll have to weigh the pros and cons to see if debt consolidation is right for you. If you play your cards right, you could end up in a better financial situation with a better credit score to show for it.
To learn more about how credit scores work, check out these related posts and articles from OppLoans:
- A Brief History of Credit Scores
- Is the Credit Blacklist a Real Thing or an Urban Myth?
- Bad Credit Repair: When to Close a Credit Card and When to Keep It Open
|Damon Duncan (@Damon_Duncan) (@DuncanLaw), is an attorney on the North Carolina Bar Association and Foundation’s Board of Governors, a member of the Elon University School of Law’s Alumni Council, the Secretary of the North Carolina Bar Association’s Bankruptcy Section and adjunct professor at Elon University School of Law and Guilford Technical Community College.|
|Marie Martin is a consumer bankruptcy attorney who has been practicing for 20 years. She is a member of the National Association of Consumer Bankruptcy Attorneys, the American Bankruptcy Institute, and the incoming Chair of the Consumer Subcommittee of the Bankruptcy Section of the Minnesota State Bar Association.|
|Carlos Perez is the Director of Counseling Services at DebtWave Credit Counseling, Inc (@debtwave).|