Over the past few years, debt consolidation has become a popular financial strategy used to simplify and make debt more manageable. It makes sense because instead of dealing with multiple high interest debts, it’s easier to manage a single monthly payment with typically a fixed interest rate. You might wonder, which banks offer debt consolidation loans? Well, it’s not just the banks, in fact, you can take such loans from online lenders and different credit unions as well.
Each lender is different and each consolidation loan comes with different terms and eligibility criteria. You must compare different lenders, the interests they offer and all the other loan terms to find the one that fits your financial picture in the best possible way. However, before applying one of the most important things you should consider is the impact of bank debt consolidation loans on your credit score- both in the short term and over time. Today we’ll break down the process in this debt consolidation guide so that you can make a more informed decision for your future.
1- Understanding The Short-Term Dip
When you apply for a personalized debt consolidation loan, your credit score will drop slightly by a few points immediately. This dip is a result of two factors;
A hard credit inquiry: When you apply for a consolidation loan, the bank first reviews your credit report and performs a hard credit inquiry. If your credit requirements don’t meet their criteria, your loan will be denied. Now, every time a hard inquiry is performed, it’ll bring your score down by a few points. In case of multiple inquiries for the same loan type in a short time period, like within 14 to 45 days, your credit score won’t suffer much because as per the credit scoring model, all those inquiries will be considered as one.
The drop in your credit score is temporary and it’s a part of the process when you are applying for a new loan.
A new credit account: After your consolidation loan is approved, it appears as a new credit account on your credit report. This affects two important components of your credit score;
- Your average account age will reduce and it’ll cause a dip in your credit score.
- Another added installment loan means credit mix which can improve your score in the long run.
2-Long Term Benefits-Building Your Score With Timely Payments
If you successfully manage the loan responsibly, you’ll see the true credit advantages of taking a debt consolidation loan. Here’s what you’ll have to do to improve your credit profile over time;
- Make Timely Payments: Most people aren’t aware that your payment history makes around 35% of your total FICO score. In simpler words, it’s one of the most important factors that you need to focus on after debt consolidation. All you have to do is to make on-time payments on your new loan and demonstrate responsible financial behavior. Over time, your consistent behavior will reflect on your credit score and it’ll improve.
- Lower Credit Utilization Ratio: Upon using your consolidation funds to pay off your credit card balances, your credit utilization ratio will decrease. For those who don’t know, credit utilization ratio is the total amount of revolving credit being used by you as compared to your credit limit.
For example, if you owe $20,000 in credit card debt with a credit limit of $22,000, this means that your credit utilization ratio was around 83%. When you use your consolidation funds to pay off the $20,000 debt, the ratio will drop to 0% and this exactly is what will help increase your credit score.
- Simplified Repayment Structure: Debt consolidation can help in multiple ways especially if it’s really hard for you to manage multiple debts all at once. When you have to focus on one single monthly payment instead of multiple payments, it reduces the risk of missed or delayed payments. Eventually, it’ll build a positive payment history and image over time and ultimately it’ll improve your credit profile.
3-The Important Of Responsible Financial Management
Without a doubt debt consolidation comes with credit growth benefits and it’s one of the best debt relief solutions but it’s not any magic fix and it won’t resolve your debt related issues overnight. After consolidation, you need to work on your financial habits to ensure that it helps improve your credit profile with the passage of time.
Spending irresponsibly and relying on credit cards or taking up new loans can lead you to an even worse position. The main key here is to practice discipline when it comes to your financial life. Most importantly, you must avoid taking any more high interest loans while you already have to focus on repaying your debt consolidation loan.
Debt Consolidation – Short Term Dip, Long Term Gain
| Credit Factor | Short Term Effect | Long Term Effect |
| Hard inquiry | A slight dip by 5 to 10 points | No lasting effect |
| New Account | It’ll reduce your account’s average age | It’ll improve your overall credit mix |
| Payment history | Will stay neutral initially | With timely payments, you’ll be able to improve it |
| Credit utilization | Will become positive once you pay off your debts | Sustained improvement when you keep it low |
Strategic Tips That Can Help You Maximize Credit Score Benefits
If you really are serious about your financial future and want to improve your credit profile after debt consolidation then here are some effective tips that can come in handy to you;
- Shop For Loans Wisely: Apply for loans in a short time window to reduce the number of hard credit inquiries.
- Keep Your Old Credit Accounts Open: If it’s possible then keep your old credit cards active but make sure they are at zero balance. This will help in preserving your credit age and credit utilization.
- Automate Your Payments: To ensure that you never miss a date or delay a payment, set up automatic payments.
- Keep A Track Of Your Progress: Make sure you monitor and review your credit score every month to see how far you’ve come and how repayment is affecting your credit profile.
Conclusion
If you want to improve your financial stability, there’s nothing better than opting for a debt consolidation loan. It might initially cause a dip in your credit score but in the longer run, if you make your payments on time and lower your credit utilization ratio, you’ll witness some great improvements in your credit score and overall profile. Additionally you can think about refinancing your loan in order to reduce interest rates and monthly payments. Just use this financial tool strategically, adopt responsible financial habits and then see how all your short term changes reflect on your financial future.
FAQs
Q1. Will Getting A Debt Consolidation Loan Hurt My Credit Score?
Yes, but it’s temporary. What happens is that when you apply for a debt consolidation loan, the lender will perform a hard credit inquiry which will drop your credit score by a few points. Moreover, when you open a new account, it can reduce the overall age of your account. However, all these impacts are short lived and if you start making timely payments, keep your credit utilization ratio low and don’t use your credit cards much then your score will improve over time.
Q2. Will A Debt Consolidation Loan Show Up On My Credit Report?
Yes, debt consolidation loans do show up on your credit report as a new installment account. This in fact can improve your overall credit mix which makes around 10% of your total FICO score. Over time, the new installment account will also help improve your overall credit standing.
Q3. Is Debt Consolidation The Same As Debt Settlement?
No, debt consolidation and debt settlement are two different debt relief solutions. In a debt settlement, you or a third party negotiates with your creditor to reduce the total amount of your loan. In exchange, you have to pay your creditor a lump sum of the total amount. Settled accounts can damage your credit score because they are marked as “paid less than agreed” on your credit report. This shows on your report for 7 years.
Debt consolidation on the other hand involves rolling all your other debts into one single monthly payment. You have to pay back the loan amount in full but at a comparatively lower interest rate.
Our focus at Mountains Debt Relief is to help you get out of debt while helping you improve your overall financial health. If you want to gain long term financial benefits and become debt free all at the same time then Contact Now!