How Debt Consolidation Affects Your Credit

One of the options available to consumers who are overwhelmed with credit card debt and other financial obligations is a debt consolidation loan. Applying for this type of loan will not decrease your score to any great extent.

However, numerous credit inquiries can have a negative impact on your overall credit rating. If you apply for multiple lines of credit within a short period of time, it can signal to creditors that you are having financial difficulties.

Credit inquiries are divided into two categories; one being a “hard” inquiry and the other a “soft” inquiry. A hard inquiry is when you yourself apply for a loan. This is always done any time someone applies for new credit. One hard inquiry will not significantly lower your score.

A soft inquiry is when a creditor asks a credit reporting agency to pull the names of all consumers who fit a certain demographic, such as a neighborhood, mortgage, etc. This type of inquiry has no effect on your credit score at all.

If you apply for a loan and are approved, you can then use the proceeds to pay off your credit card debt. If only one card is fully paid off, it will probably have a minimal effect on your score. If the loan can be used to pay off more than one credit card account, then your score may improve slightly.

Experts agree that taking on new debt (a consolidation loan) to improve your credit score is a risky proposition. When you use new debt to pay off old debt it is not really addressing the most important issue which is reducing your overall debt. The only instance when it might be considered advantageous to get a consolidation loan is if the interest rate on the loan is much lower than the rates on the credit card accounts you are retiring.

If you are considering a debt consolidation program, this is an entirely different option than a debt consolidation loan. In this case, either you or the debt consolidation company with whom you contract, works with your creditors and negotiates a settlement amount on all of your delinquent accounts. This is normally a substantially reduced sum. This option for debt relief will lower your credit rating for the next few years although it does not affect your credit as severely as a bankruptcy. You will mostly likely find it harder to get favorable terms for new credit and you will be charged higher than normal interest rates.

The purpose of a debt consolidation program is to allow you to make regular monthly payments that you can afford. It is important to always make these payments on time and not to miss any payments. Slowly, if you pay your bills in a timely manner and fulfill your obligations under the debt consolidation program, your credit will improve. Creditors will see that you have made an honest commitment to pay off your debt (even at a reduced amount) and you should be considered less of a credit risk in the future.

Before entering into any new debt, consider all the options available and weigh the risks and consequences of each. There are many ways for consumers to reduce their debt- whether it’s credit cards, personal loans, or monthly bills. Investigate the choices open to you and thoroughly go over your own situation. Only then can you make the best decision.