In its most general definition, debt consolidation refers to any time an individual or company takes out one loan to pay off many other debts. A company might do this if it took out several small loans to finance growth and now finds interest rates lower than they were for the original loans. Most often, we hear the term in reference to consumer debt. We’ve all seen ads that promise the moon when it comes to debt consolidation. “Debt relief is just a call/click/email away!” “Slash your payments!” “Reduce your interest rates!”
Debt consolidation, when undertaken using a sound lender completely on the up and up, can help reduce your monthly payments while increasing your credit score. 30% of your FICO score is determined by revolving charges and credit card debt. One of the easiest ways to improve your score is to pay outstanding credit card debts. Consolidating credit card or other outstanding debt into a mortgage refinancing or home equity loan can do just that. Your credit card balance will be instantly lowered, improving nearly one third of your credit score.
The second benefit of consolidation is a lower debt-to-income ratio. The lower your debt is in relation to your income, the higher your FICO score. This may sound a little counter-intuitive, because your credit card debt will be transferred to another type of loan. You might find yourself thinking that you’ll still owe just as much, but to another lender. That much is true, but the interest rates affixed to home loans and respectable consolidation loans is much lower than that of credit cards. That should reduce your monthly payments. In other words, you’ll be able to pay down the debt much sooner. And as your debt goes down, your score goes up.
For those in seriously dire straights due to credit card debt, consolidation may be a powerful stopgap to prevent bankruptcy. Credit card interest rates are often above 20%. Letting balances snowball can leave you owing much more than you originally purchased, have you paying monstrous amounts of in interest, and put you under enormous financial pressure. Bankruptcy can adversely affect your credit score for years. If you’re forced to choose between consolidation and potential bankruptcy, consolidation is the way to go. If reducing your payments to help you avoid bankruptcy, don’t wait. Start looking into consolidation loans as soon as possible.
If you’re seriously underwater with old credit card debt, it may be a good time to see if a debt settlement service can help you out of the fire. Debt settlement is another tricky business. You should thoroughly vet any firm you consider doing business with. That said, if you’ve missed payments on your credit card balances and have received collection notices from a third party collector, a debt settlement arrangement could be right for you. Many times, creditors will sell “bad debts” to other companies for pennies on the dollar. These companies are often willing to settle such debts for very small amounts. An upright and professional debt settlement agency can potentially help you out of a hairy financial situation. Also, removing outstanding balances from your credit report will also help your score.
You may also be able to consolidate your settled debt into another loan. However, always be on the lookout for nefarious practices and uncompetitive consolidation loans. If a service offers you settlement and consolidation results that sound too good to be true, pay strict attention to the loan terms. Make sure you’re being charged a competitive interest rate.
The only way a consolidation can negatively affect your FICO score is if you apply for too many consolidation loans. This problem can be avoided if you apply at multiple lenders within 30 days. All of these applications should count as “soft hits” on your credit score, and shouldn’t greatly reduce your FICO score. If you’re on the fence about consolidation, consider this last option: call your card company and negotiate a lower rate. Explain that you’re considering a consolidation, and that if they don’t reduce the rate you’ll be more likely to consolidate. Many companies would rather retain the balance and still have the revenue from your interest, and representatives are often authorized to change rates on the spot.
A great way to start the debt consolidation process is to sign up for a free account at DebtGoal. There, you can track all of your debts with an easy to use interface that will allow you to see just how much you need in a consolidation loan.
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This post was right on time and right on the money. I had several debts on my credit card and felt a little overwhelmed. I applied for a consolidation loan through Lending Club and feel so much better. I paid off my credit cards and I’m not paying 1 monthly fee as opposed to several. I believe my debt to income ratio has gone down and I’m hoping my credit score has gone up!
Question: how long does it take for your credit score to take a consolidation into account AND will this negatively or positively affect me if I’m looking to buy a home?