Debt consolidation loans allow people to combine their debts into one loan. If interest rates are low, a debt consolidation loan lets you put all your debts into a new loan with a potentially better interest rate. This can help you save you money each month on interest.
However, debt consolidation can affect your credit score. In this article, we’ll explain how.
- Will a debt consolidation loan affect your credit?
- How a debt consolidation loan can help your credit
- How a debt consolidation loan can hurt your credit
- Steps to take when consolidating debt
- What to avoid when consolidating debt
- Debt consolidation alternatives
- The bottom line
Will a debt consolidation loan affect your credit?
Many people wonder, “Does debt consolidation affect your credit?” The short answer is yes. A debt consolidation loan may hurt your credit score. However, it can also improve your credit history.
The impact on your credit from debt consolidation is usually temporary, and your credit can grow in the long run. It’s important to know that even though your credit score may be affected temporarily, it can still be beneficial, depending on your situation. This is because it reduces the number of monthly payments you have to make. Plus, you might save money on interest if you get a better interest rate.
How a debt consolidation loan can help your credit
A debt consolidation loan can help and hurt your credit, but it’s not as simple as it seems. It all depends on how you manage it. Let’s explore how debt consolidation can benefit your credit below.
Improved credit score
When you get a debt consolidation loan, the lender pays off your old debts, so you only have one new loan to pay. This is good for your credit score because credit reporting agencies will see that your debts are now paid off.
Consolidating debt closes multiple credit accounts and replaces them with one loan. This reduces your overall credit utilization, which is an important factor in determining your credit score.
Better payment history
Paying your bills on time is important for your credit score. On the other hand, missing or late payments can lower your credit score.
When you consolidate debt, you only have to worry about one monthly loan payment. This can make it easier to pay on time and improve your payment history. Over time, your credit score will go up.
How a debt consolidation loan can hurt your credit
Is debt consolidation bad for credit? While debt consolidation can be helpful, it can also have a negative impact on your credit, at least for a little while. So, does debt consolidation hurt your credit in a negative way? The answer is that it can, especially at first.
Here’s how a debt consolidation loan might temporarily lower your credit score:
Applying for new credit
Applying for new credit will always affect your credit score. A debt consolidation loan is considered a new form of credit. The lender will do a credit check, which is called a hard inquiry. This can temporarily lower your credit score by a few points.
In this case, the application process can have a small yet temporary negative impact on your credit.
Opening a new credit account
When you get a new line of credit, like a personal loan for debt consolidation, your credit score might decrease for a little while. However, if you make your payments on time, your credit score should increase again. This is why it’s important to manage your loan responsibly after consolidating debt.
Lowering your average age of credit
Credit scoring models like you to have older accounts because they show you have a longer history of making timely payments. This can help keep your credit score higher. However, when you open a new account for debt consolidation, it affects your credit in two ways:
- The average age of all your accounts goes down.
- A new account without any payment history is introduced into your credit mix.
These factors can briefly lower your credit score. However, this dip is temporary and the long-term effects of credit consolidation can be positive if you manage the new loan responsibly.
Steps to take when consolidating debt
Here are some important steps to follow when consolidating your debt:
Shop for low interest rates
One of the main reasons people consolidate debt is to get a lower interest rate. It’s important to thoroughly research and talk to several lenders to find the lowest interest rate possible. This will help you save money on interest every month and make it easier to pay down your debt faster.
Remember, debt consolidation is helpful when you can get a lower interest rate than what you currently pay on your existing debts. A lower interest rate can indirectly help your credit by making it easier to consistently make payments on time.
Read the fine print
Understanding the details and terms of your debt consolidation loan is important. The terms will let you know how long you have to pay it back, how much you owe, the interest rate, and any fees you have to pay. If the loan has good terms, it can help you manage your credit. Unfavorable terms can make it harder for you and hurt your credit.
Make your monthly payments on time
Making your monthly payments on time is essential for a good credit score. It shows you’re responsible and will help improve your credit in the long run. If you can, set up automatic payments to ensure you never forget to pay the loan balance on time.
What to avoid when consolidating debt
Here are some essential things to avoid when consolidating debt:
Missing payments
Missing payments is the worst thing for your credit score. When you miss a payment, it hurts your credit score. You may also have to pay extra fees for being late, which adds to your debt.
This is especially important to remember when thinking about how debt consolidation affects your credit. The purpose of consolidation is to make your debt easier to manage, so missing payments defeats that goal.
Taking the longest loan term available
A longer loan term can lower your monthly payments right away, but it’s not always the best choice. Extending the time it takes to repay the loan adds extra months or even years of interest to your debt. This means you’ll have to pay more money in total.
While the length of the loan doesn’t directly affect your credit score, it can make it harder for you to improve your financial situation in the future. It’s best to find a balance that fits your budget. Try to aim for the shortest term you can comfortably manage.
Running up credit card balances again
The last thing you want to do is start accumulating more debt on your credit card. Avoid using your credit cards again until your loan is paid.
Applying for more loans
Avoid applying for new loans when you’ve consolidated your debt for two main reasons:
- Applying for another loan means you’ll have one more monthly payment. This can complicate your financial situation again.
- Your credit score will likely be slightly lower after getting a debt consolidation loan. This temporary dip makes your application less appealing to lenders. This can result in unfavorable terms or rejection.
Debt consolidation alternatives
Debt consolidation can be great for managing multiple debts. However, it’s not the only option available. Here are some alternatives to consider:
- Debt snowball method: Pay off small debts first and make minimum payments on larger loans and debts. As each small debt is paid off, the payment rolls into the next one, creating a “snowball” effect. This method can be motivating as you see different types of personal loans and credit card debt disappear quickly, but it may not save as much on interest as other methods.
- Balance transfer credit cards: A balance transfer card with a 0% introductory APR period can be helpful if you have credit card debt. This lets you transfer high-interest card balances to a new card and pay no interest for a set period. However, this involves opening a new credit account, which can temporarily impact your credit score.
- Negotiation: You can try talking to your creditors to negotiate lower interest rates or settle for less than you owe. This can be helpful if you have a good payment history or are experiencing financial hardship. While settlements can lower your credit score, negotiating lower rates can make it easier to pay off debts faster.
- Personal budgeting and lifestyle changes: Creating a budget and making significant changes can free up more money to pay off debt. This method doesn’t directly impact your credit and can lead to long-lasting financial habits.
The bottom line
A debt consolidation loan can help combine all your debts into one loan. If you get a loan with good terms, you can save money on interest rates. While it’s not a solution for poor money management, it can improve your financial health.
Consolidating your debt with Sun Loan can streamline your debt and improve your credit. You can apply for a debt consolidation loan online or visit one of our local branches. A loan specialist will guide you every step of the way. We’re also available to answer any questions you have–call us at (800) SUN-LOAN!
