If your credit card bills are piling up and you cannot juggle anymore, a balance-transfer card or loan can consolidate your debt, but doing so might have a lasting effect on your credit. While combining your outstanding balances can simplify repayment, reduce stress, most significantly, save you money on interest over time, this approach can ding your credit score and history if you are not careful.
Debt consolidation can hurt the credit score in many ways, but it depends on which method you are using. For people using a debt management strategy for consolidation, it’s essential to completely understand your agreement with your credit counselor. It’s essential to know whether you’re working with a credit counselor from a not-for-profit organization, or if you’re working with a for-profit debt settlement or consolidation firm.
Advantages of debt consolidation
If you are considering a debt consolidation loan, there are a few obvious advantages to doing so.
Could lower your credit utilization
If you have debt from revolving credit (like a credit card), you can change it to installment credit through a debt consolidation loan. Credit scoring models treat revolving and installment credit differently usually, revolving credit has a big effect on your credit through your overall credit use, which is the percentage of your total available credit that you are using. Reducing your credit use via debt consolidation can give a bigger boost to your credit score.
Might help diversify your credit
Taking out a debt consolidation loan means you will be adding a new type of loan to your credit mix. Credit scoring models see that you can handle both revolving and installment credit, so by diversifying the types of debt you have, your credit can improve.
Puts you on a set repayment schedule
If you decide to use a personal loan to pay off your debt, you will have a fixed every month payment with a set repayment term. This can make it less tempting to continue adding to your debt compared to a balance transfer card. As you pay down your debt, you will probably see your credit score go up.
Most times, when a customer takes out a debt consolidation loan, the overall cash outlay monthly is lower. This can help a customer to avoid taking on new debt and, maybe, begin saving money rather than spending into the negative monthly. Creating and funding a savings account can help customers avoid going into debt when faced with an emergency expense like a medical bill or an expensive car repair.
Disadvantages of a debt consolidation loan
Consolidation loans carry with them specific disadvantages. If customers aren’t disciplined and do not change their spending habits, a debt consolidation loan can put them in a worse situation. Actually, if customers are not careful and diligent, they can pay more in interest over the life of the loan.
Paying more interest in the long run
Debt consolidation loans can low every month payments and provide important relief for customers who are struggling under a heavy debt load. However, customers need to be familiar with consolidation loans can frequently mean paying more interest in the end. Customers who use the equity in their houses are probably looking at important closing prices and long loan terms. This means that customers can be paying interest on their debt for up to 30 years.
No change in spending habits
Several customers find that after they consolidate their debts, their life changes very small. Any savings realized from their debt consolidation seem to disappear rapidly in their daily spending. If they have not altered their habits and do not budget their money going forward, they’re probably to find themselves overwhelmed with debt once again.
Credit applications trigger hard inquiries that temporarily low credit scores by some points; many applications over an extended period will have a greater impact.
A new account has no payment history unless on-time payments are consistently made.
The average age of credit accounts drops with a new account; the old the average, the good.
If the debt is transferred to a card with a low credit limit, the credit use rate will increase and that’ll low your credit score.