Does debt consolidation improve your credit rating?
Our goal at Credible Operations, Inc., NMLS Number 1681276, hereafter referred to as “Credible”, is to give you the tools and confidence you need to improve your finances. Although we promote the products of our partner lenders who pay us for our services, all opinions are our own.
Debt consolidation is the process of combining multiple outstanding balances into one account. You can do this through a credit card balance transfer, personal loan, or line of credit, which makes your debt more manageable and even saves you money by reducing service charges. ‘interest.
But debt consolidation can also affect your credit. Here’s an overview of how it can improve your credit, how it can potentially hurt your credit score, and different ways to consolidate your debt.
Credible allows you view your prequalified personal loan rates from various lenders, and it will not affect your credit score.
How Debt Consolidation Can Help Your Credit
A debt consolidation loan can help you build or improve your credit rating in several ways:
- This can lead to a faster gain. When you consolidate your debts into one account, you may be able to lower your interest rate or your monthly payments. This could allow you to pay off more of your balance each month than when juggling multiple accounts, allowing you to get out of debt faster. And the sooner you reduce your balance, the better your credit rating will be.
- This can reduce your use of credit. Your credit utilization ratio is the amount of credit you are using compared to the amount of available credit you have. By moving your debt from, say, one credit card at most to a new line of credit, you reduce the use of your credit for that account. Depending on the amount of your previously available credit limit, your score could increase.
- This can increase your credit mix or your payment history. If you only have credit cards on your credit report, adding a personal loan account could add to your credit mix, which can boost your score when making payments on time.
Streamlining your debt comes with many financial benefits. But debt consolidation can also hurt your credit in many ways :
- Hard credit draws can lower your score. Lenders will do a thorough investigation when considering your application for a new loan or credit-based product. This can temporarily lower your credit score by a few points. The more difficult requests you have in a short period of time, the more you can expect your score to drop.
- The new credit affects the average age of your accounts. If you take out a new loan or line of credit to consolidate your existing debt, it will reduce the average age of your credit accounts, which can also cause your score to drop.
- This may affect your total available credit. If you transfer multiple balances to a new type of credit – a balance transfer card, for example – and then cancel paid cards, this reduces the total amount of credit you have. This can negatively affect your credit utilization rate.
Fortunately, the effects of debt consolidation are usually short-lived. By making your new loan payments on time and reducing what you owe, any temporary change in your credit score will usually begin to correct itself within a few months.
What constitutes your credit rating?
Technically, you have many different credit scores, depending on the scoring model used by a lender. The most commonly used scoring model is FICO, provided by the Fair Isaac Corporation.
FICO considers these factors when calculating your score:
- Payment history (35%) — Your payment history is the most important factor that determines your credit score. An on-time payment history shows lenders that you are more likely to repay a loan.
- Amount due (30%) — This is the total amount of credit you owe compared to your available credit.
- Average age of accounts (15%) — This includes how long you’ve been managing your credit-based accounts, the age of your oldest account, the age of your newest account, and how long you haven’t used certain accounts.
- New lines of credit (10%) — Lenders also consider accounts with a short history and recent applications for new credit.
- Composition of credit (10%) — Your credit mix is the different types of credit-based accounts you own and manage, such as auto loans, credit cards, and student loans.
If you want to see what rates you might qualify for without hurting your credit, visit Credible for compare personal loan rates from various lenders in minutes.
How to Build Your Credit Score After Taking Out a Debt Consolidation Loan
- Make payments on time, every time. A debt consolidation loan can help you build a strong credit history, but only if you make your monthly payments on time and in full.
- Create a budget. Your budget should take into account your new loan payment and other monthly bills, and you can also use it to avoid overspending.
- Avoid creating new credit card debt. Once you’ve paid off your credit card balance, it’s important to limit (or even avoid) additional credit card purchases, especially if your budget doesn’t allow you to pay the statement balance in full. each month.
Personal loan or credit card with balance transfer: which one to choose?
Taking out a personal loan and transferring balances to an existing credit card account are two popular options for consolidating debt. But what is the best choice?
The answer really depends on how much you owe, your available credit, and the interest rate you qualify for. For example, if you have multiple accounts and higher balances, subscribing to a A $20,000 personal loan can be more cost effective than transferring six different balances and paying credit card balance transfer fees each time.
- You’ll repay the loan in fixed monthly installments, which can make budgeting easier rather than juggling multiple credit card balances.
- They usually come with lower rates than credit cards.
- They can facilitate the consolidation of multiple debts and balances.
- They may have higher credit score requirements to qualify.
- They do not have a 0% introductory interest rate.
- These are not revolving credit products, so you cannot withdraw more money from them in the future, even after your balance has been paid off. If you need additional funds, you will need to apply for a new personal loan.
Balance transfer credit card
- They usually offer 0% introductory APRs with no balance transfer fees for a certain period of time, which can save you a lot of money upfront.
- They can include cards you already have, helping you avoid opening new accounts or difficult credit applications.
- They often revert to double-digit interest rates once the promotional period ends, and can get very expensive if you don’t pay off the balance in full by then.
- They may incur charges for each balance you transfer to the card.
Other Ways to Consolidate Debt
You can use several different financial products and approaches to consolidate your debt. Here are some of the most common:
- Home equity line of credit — HELOC allow you to tap into the equity in your home. A HELOC, which is secured by your home, works the same way as a credit card. You will have an established credit limit that you can draw on as needed, at an agreed interest rate.
- Home equity loan — A home equity loan is also secured by the equity in your property and works like a personal loan. You will receive a lump sum that you repay in monthly installments at a fixed interest rate.
- Refinancing by collection — If you have accumulated enough equity in your home, a cash refinance may allow you to withdraw some of this cash value, which you can then use for any purpose (like paying off debt). Cash-in refinancing can also allow you to lower your interest rate or adjust your monthly payment amount.
- Retirement account loan — If your plan allows it, you can use a 401(k) loan or another retirement account to consolidate your debt, but that’s usually not a good option. Depending on the type of account and your age, you may have to pay penalties, interest and taxes on the amount you withdraw. Plus, withdrawing that money before retirement can derail your future financial security.
Why taking out a debt consolidation loan can save you money
When it comes to getting out of debt – what does it entail credit card balancesmedical bills or other credit accounts – taking out a personal loan for debt consolidation can be a good option.
A personal loan can allow you to reduce high interest rates (especially when it comes to credit card balances), making it easier to pay off your debt for a lower total cost. It also lets you streamline your debt into one account with one monthly payment, which is easier to manage.
Finding the right personal loan is the first step towards debt consolidation.
If you’re ready to apply for a personal loan to consolidate your high-interest debt, visit Credible for quick and easy compare personal loan rates from various lenders in minutes.