Consolidating debts into one payment and paying as agreed can help your credit and make budgeting easier – but there are risks as well. Consolidating your debt can lower your monthly payments, but it can also cause a temporary dip in your credit score. Two common debt consolidation approaches include getting a debt consolidation loan or a balance transfer card. Both types require a hard enquiry on your credit, which can lower your credit score by a few points. But if you change the habits that led to debt and pay on time, every time, the overall effect should be positive. Here is a closer look at the potential impact on your credit when you consolidate your debt with a personal loan or balance transfer credit card. We ask: do consolidation loans hurt your credit score?
Debt consolidation combines several debts into one, ideally with a lower interest rate and a faster payoff. Having fewer payments to juggle and saving on interest can help you pay off debt.
– Generally requires a lower credit score for approval than a balance transfer card.
– Can help improve credit mix if you had only credit cards before, because it is an instalment loan.
– Can combine several payments into one, simplifying your finances.
– Can improve credit by lowering the amount of credit limit you are using, known as credit utilisation, if unsecured credit card bills are moved to an instalment loan.
– It can lead to even more debt if you use newly available space on credit cards.
– If you end up overextended and unable to pay, late payments can damage credit.
– Paying high fees to borrow money.
– Having a prepayment penalty.
– Lower interest rate, including a 0% APR for excellent credit consumers.
– Flexible payments.
– No prepayment penalty.
– A lower credit score because of high credit utilisation.
– Not paying off the debt before the offer runs out, resulting in higher interest rate.
If those options do not seem like a good fit, there are other debt consolidation options that also can affect your credit. Keep in mind it is generally not a good idea to replace unsecured debt with secured debt because you could lose your home or vehicle if you cannot pay.
– Home equity loan or line of credit: Will be reported as an instalment loan or revolving account, depending on which you get. You will also get hot with a credit check.
– 401k Loan: Does not appear on your credit report, so it has no effect on your credit score.
– Debt management plan: Seeing a credit counsellor and signing up for a debt management plan does not directly affect your credit score, but negotiating to pay less than the full amount due or closing credit cards can hurt your score. A DMP is noted on your credit report while it is in effect, but not after the plan is completed.