Does Debt Consolidation Hurt Your Credit
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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 are getting a debt consolidation loan or a balance transfer card.
Any credit application typically triggers a hard inquiry on your credit, which can lower your credit score by a few points for a few months. But the overall credit effect of debt consolidation should be positive, if you make sure to pay on time and change the habits that led debt to stack up.
Heres a closer look at the potential impact on your credit when you consolidate debt with a personal loan or balance transfer credit card, plus some other debt consolidation options.
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+ How does it work? At Bromwich+Smith we offer a powerful debt relief solution called a Consumer Proposal, which usually reduces debt to only a percentage of original amount owed. The rest is forgiven.
+ Eliminating debt shouldn’t cost you more money! Only a Licensed Insolvency Trustee like Bromwich+Smith has the legal authority to administer a Consumer Proposal for you. In fact, if an online or offline debt relief service offers a Consumer Proposal, ask if they are Licensed Insolvency Trustees. If they are not, they will by law be required to engage an external Trustee, which could add their unnecessary fees to the process.
+ Legally binding on all creditors, including CRA Taxes, Credit Cards, Payday Loans, Bills and all other unsecured debt.
+ Up to 5 years to pay, interest free! Get off the interest treadmill. There are absolutely no interest charges with a Consumer Proposal, and a Proposal can be paid over 5 years, with all debt combined into a single monthly payment.
+ Immediately stops all creditor calls and actions. All creditor collections and legal actions must stop. No more bothersome calls or stressful letters. If wages are being garnisheed, this too is stopped.
+ Does not involve your assets. Your home, car and other possessions are not touched by a Consumer Proposal.
+ No Hidden Fees. We are paid out of the settlement to your creditors.
When It Makes Sense To Consolidate Your Debt
The most common reason to consolidate your debt is to save money on interest. If you can consolidate your debt and get a lower interest rate, you could save hundreds or even thousands of dollars in total interest.
Another popular reason to consolidate debt is to simplify your monthly payments. If you struggle to pay your bills on time because of differing due dates, consolidating could make it easier to manage your finances.
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If I could give 12 stars I would. From the help desk to meeting Doris my credit counsellor, it was a great experience!! She was very courteous, took time to explain everything to me, made sure I understood easily. She made me feel comfortable through the entire process. She made me feel that she was there to help me and that I matter. Thank you Doris and Credit Canada.
Using A Balance Transfer Card
Instead of taking out a personal loan, you could apply for a credit card that allows you to transfer and combine the balances onto a single card. Look for a card that has no balance transfer fee and an interest rate of 0% for at least a year.
“In many cases, I think finding a credit card that offers an introductory 0% APR for a period of time and does not charge a fee for balance transfers is a good way to go,” Roberge says.
But this strategy is also not without pitfalls, he says. “The biggest thing to be careful with if you go that route is to ensure you make every single payment on time and in full,” Roberge says. With most 0% APR offers, if you miss even a single payment or pay late, you nullify the 0% offer and have to pay interest on the full balance. It’s important to read the fine print of the card agreement before signing up, as well as assess your own personal habits.
If you can’t guarantee that you’ll be able to pay the card every month, you could end up even more in the hole, Roberge says. Especially if the APR on the new balance transfer card is higher than the original cards. “Set up an automatic payment, set calendar reminders whatever you have to do to make sure you don’t miss any payments,” he says.
Additionally, you may be approved for a balance transfer card, but not approved to transfer over the full balance of your outstanding debt. In that case, you may need to take out multiple cards, slightly defeating the purpose of a clean consolidation plan.
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Debt Consolidation Can Have Multiple Meanings
Another source of confusion in assessing how debt consolidation affects your credit is that “debt consolidation” is used to mean more than the debt consolidation loan options reviewed above, all of which involve paying off your original debts with new debt. Debt consolidation is also used to describe two debt solutions that don’t pay off your current debts but consolidate your payments, so you are working to resolve your debts while making one monthly payment. These two options are::
- Debt settlement, where you may be able to pay off your debts at a fraction of your balance.
- A debt management plan offered by a Consumer Credit Counseling Service can reduce your interest rates and shorten the time it takes to get out of debt.
Debt settlement hurts your credit in the short-term. Creditors are willing to settle debts only when they have gone delinquent, and the delinquencies are reported to the credit bureaus and harm your credit score.
A credit counseling service’s debt management plan requires you to stop using credit and often close all the accounts you enroll. The consequence is that it hits your credit utilization, so even though the notation that your accounts are being managed by a third-party doesn’t directly lower your score, the practical effects of the program will.
If you are in financial hardship and less concerned about your credit’s negative impact, then these are debt consolidation options to consider.
How A Debt Consolidation Loan Can Hurt Your Credit Score
If you make all of your payments on time, a debt consolidation loan can’t hurt your credit in the long-term. While applying for the loan requires a hard inquiry into your credit, which could cause a slight dip in your credit score, it is only temporary. The exception would be if you are working with a credit counselor that requires you to close your accounts.4 However, sometimes life happens. Just one missed payment could result in a negative impact to your credit score.
Payment history is the most important factor in calculating your credit score, accounting for 35% of your FICO score.4 But, only you can decide if debt consolidation is a good idea for your situation.
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Consolidating Debts Without Ruining Your Credit
When you have a lot of debts, consolidating them down to one, easy to manage repayment makes a lot of sense. It simplifies your bookkeeping, can reduce the overall interest rate you are paying, and can help you pay off your debts faster. However, consolidating your debts can have a negative impact on your credit score.
Fortunately, there are ways to consolidate your debts without ruining your credit.
Personal Loan Vs Balance Transfer Credit Card: Which Should You Pick
Taking out a personal loan and transferring balances to an existing credit card account are both popular options for consolidating debt. But which is the better choice?
The answer really comes down to how much you owe, your available credit, and what interest rate you qualify for. For example, if you have multiple accounts and higher balances, taking out a $20,000 personal loan may be more cost-effective than transferring six different balances and paying credit card balance transfer fees each time.
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What If I Dont Qualify For A Debt Consolidation Loan
Debt consolidation is not for everyone. In fact, many people who are looking for consolidation loans are beyond the point where a loan can help them. They may have too much debt to qualify, or their credit is too poor to receive a beneficial interest rate.
If you find that lenders arent willing to approve you, then you may need to consider other options. First, you should contact a organization. They can evaluate your debts and budget to help you identify the best solution for your needs.
In many cases, they may recommend a debt management plan. This is a repayment plan that the credit counselling organization can help you arrange. It minimizes the interest applied to your balances and allows you to repay your debts with a single monthly payment, similar to consolidation.
This can be a good option for relief for people who cant qualify to consolidate on their own. If you can afford to repay everything you owe, then working with a credit counsellor could be your best option.
If you cannot reasonably afford to repay everything you owe, even with reduced interest, then it may be time to consider more aggressive solutions. For example, you may want to consider debt settlement through a consumer proposal.
A Licensed Insolvency Trustee will review your finances and determine how much of your debt you can afford to pay back. They set up a 60-month repayment plan that pays back as much of your debt as possible. Then the remaining balances are discharged.
How Consolidating With A Personal Loan Can Hurt Your Credit Score
Here are some of the ways a personal loan can hurt your credit score if you aren’t careful:
- It opens up more credit: With your credit card balances gone, you have more credit available to spend. Using your available credit can undo the benefits of consolidating debt.
- It lowers your average account age: The average age of all your credit accounts makes up 15% of your credit score, and the higher it is, the better. Adding a new account will bring the average age down, temporarily lowering your credit score.
- It creates a fixed payment: If you can’t afford the monthly payment, your lender could report your payment as 30 days late to the credit bureaus. Even one late payment can negatively affect your credit score.
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Tips For Consolidating Debt Without Hurting Your Credit
While everyones situation is different, there are a few ways to lessen the impact to your credit while you consolidate your debt.
- Pay off your revolving debt first. Revolving debts like credit cards tend to have a higher impact on your credit score than installment loans. Prioritizing a zero balance on your revolving debts could help to increase your credit score faster.
- Make more than the minimum payment. If your situation allows for it, you should try to pay more than the required minimum on your consolidated loans. This will make sure that more of your payment goes to your principal instead of just covering interest.
- Make on-time payments.Making on-time payments shows creditors that youre serious about getting your credit score back on track. You can also consider consolidating with a credit builder loan so that your payments are automatically reported to the credit bureau.
- Apply for a limited number of products.Only apply for loans or credit cards that you know youre qualified for. Doing this will help you avoid multiple hard pulls on your credit, which can negatively affect your credit score.
What does getting a hard pull on your credit mean?
S To Consolidate And Manage Credit Card Debt
Remember, just because itâs possible to consolidate credit card debt doesnât mean that itâs always right for everyone. If you decide credit card debt consolidation is right for you, there are several ways you can do it. There may also be other ways to manage your debt. Here are a few examples:
1. Balance Transfers
A balance transfer can be used to consolidate multiple balances into one credit card account. Part or all of your debt from other cards is moved to the balance transfer card. And you then make monthly payments to the new card going forward.
If youâre interested in this option, it also might be worth considering
- How long introductory interest rates apply to transferred balancesâand whether the rate will apply to new charges you make.
- How your rate could change over timeâand what it could cost youâif you donât pay off your debt.
- Whether any transfer fees will be added to your transferred balance.
You can get help finding credit counselors from the National Foundation for Credit Counseling and the Financial Counseling Association of America. Both are recommended by the CFPB.
Once you find a service, the CFPB also has a list of questions to ask about credit counseling. In general, the agency recommends
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How Can Debt Consolidation Hurt My Credit Score
While there’s a definite upside to the ease of a single payment and thetemptation of a lower interest rate, consolidation can hurt your creditscore in a few ways. But some simple strategies can help minimize theimpact.
- New credit inquiries: Each time you apply for a loan or a credit card, you’ll incur a hard inquiry on your credit report. Since , several inquiries and new credit accounts in a short period can lead to a drop. To minimize the impact, check your credit score in advance, so you can confirm with the lender or card issuer that your credit score is sufficient for the loan or credit card you want. And then apply for just one loan or card for your debt consolidation.
- Increased credit utilization: If you use a new loan or credit card to consolidate and then close the credit lines you’ve rolled into the new debt, you could decrease your available credit and thereby increase your credit utilization. A better choice: Instead of closing credit cards, cut up those that you’ve moved your debt out of. That way, you won’t be tempted to use them, but they’re still in your name and contributing to your overall available credit.
- Lower age of credit: New accounts can lower the average age of your credit accounts. Credit history length accounts for roughly 15% of your overall credit score. This is another reason why keeping unused credit card accounts open after consolidation is so important.
Hard Inquiries Ding Your Credit Report
When you apply for a new credit account to consolidate debt, the lender will check your credit, leading to a so-called hard inquiry on your credit report. Each hard inquiry can temporarily lower your credit score by up to five points because lenders look at new credit applications as a sign of risk.
To avoid a big hit, only apply for a loan or balance transfer card you can qualify for. Dont apply for new accounts left and right and cross your fingers for approval. Multiple hard inquiries created by a credit card or personal loan application in a short period of time will definitely hurt. While those inquiries will only impact your credit score for a year, the records will linger on your credit history for two years, which could be a red flag to future lenders.
Check your credit score before applying and take note of how your score is categorized: Is it considered fair, good, or excellent? Use that information to guide your loan or credit card selection.
On the plus side, if you are consolidating debt, you likely wont open another new line of credit any time soon, so a temporary dip in your credit score may not matter.
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Can Debt Consolidation Hurt My Credit Score
Debt consolidation has the potential to hurt your credit score in several ways, depending on which method you use. For people using a debt management plan for consolidation, it is important to fully understand your agreement with your credit counselor. It is also important to know whether you are working with a credit counselor from a not-for-profit organization, or if you are working with a for-profit debt settlement/consolidation firm.
Have A Fixed Repayment Schedule
If you use a personal loan to pay off your debt, youll know exactly how much is due each month and when your very last payment will be. Pay only the minimum with a high interest credit card and it could be years before you pay it off in full.
Takeaway: By having a fixed repayment schedule, your payment and interest rate remain the same for the length of the loan, theres no unexpected fluctuation in your monthly debt payment.
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Debt Consolidation: Negative Effects On Credit
While every debt consolidation option has its own unique effect on your credit rating there are a few negative effects you should prepare yourself for:
- Debt Consolidation Cant Help Bad Habits: How you treat your credit after youve consolidated your debts is extremely important. If you simply fall back into old habits youll end up hurting your credit score again.
- Lower Credit Age: While it might seem like a good idea to close a credit account to prevent yourself from using it, this will, in fact, hurt your credit score. One of the factors that affect your credit score is the average age of your credit accounts. Closing old ones and open new ones will, unfortunately, lower your average credit account age which will negatively impact your credit.
- Hard Inquiries: When applying for a debt consolidation loan, lenders will perform a hard credit check which results in a short-term dip to your credit. This usually isnt a big deal and is quickly regained as you pay back your debts.