When a person is drowning under a significant amount of debt, they have many options. One of these is to take out a debt consolidation loan. With a debt consolidation loan, the entirety of a person’s debt, or a portion of it, can be consolidated into one loan. The borrower then makes monthly payments, which are generally lower than the payments made on the original debt. There are many types of debt consolidation approaches but the two most common are using a loan or a balance transfer card.
Debt consolidation is very helpful for many people. However, there are things to watch out for. Consolidating your debt can cause your credit score to drop, but it is likely only temporarily. Overall, debt consolidation can actually help your credit score, but only if you do it right.
How Does Debt Consolidation Affect Your Credit?
Just as when you are applying for any loan, a debt consolidator or other lender will run a hard inquiry to the major credit reporting bureaus, such as Equifax and TransUnion. Any time a hard inquiry is made into your credit report, it will drop your credit score by at least a few points. Your score will likely remain lower for a few months. However, if you make payments regularly and on time, and change some habits that resulted in debt stacking up, the impact of a debt consolidation loan on your credit score will be positive.
Your Credit and Debt Consolidation Loans
It is not uncommon for people to consolidate their debt by taking out a personal loan from their bank or another lender. Like all other debt consolidation methods, this has many pros and cons when it comes to your credit score. The advantages of doing this are as follows:
- Approval with low credit score: If you are suffering from significant debt, there is a good chance your credit score has already taken a hit. Generally speaking, it is easier to obtain a personal loan with a lower credit score than it is when applying for a balance transfer card.
- Credit mix: Having a combination of different types of credit can help your credit score because it shows you know how to handle different types of debt. If you need the loan mainly for credit card debt, applying for an installment loan, such as a personal loan, can improve your score by providing you with a mix of credit.
- Simplify your finances: By combining all of your debt into one, it can simplify your finances, which will make them easier to manage.
- Lower the amount of credit you are using: One of the main factors used to determine your credit score is the amount of credit you are using. If you have mainly credit card debt and use the loan to pay it off, you will have more credit available, which will improve your credit score.
Although debt consolidation loans have many benefits, they do have some drawbacks. These include:
- More debt: Once you pay off the original debt and free up some credit, you may rack up more debt if you tap into that credit. This will not only lead to more debt but will also lower your credit score.
- Missed payments: If you do not pay the loan regularly, it will hurt your credit just as the original debt did.
- High fees: It is essential that you understand the annual percentage rate (APR) you will pay on the new loan. If it is too high, it can make it more difficult to pay and hurt your credit score.
- Prepayment penalties: Sometimes, loans have a penalty for prepaying because lenders prefer regular profit over an extended period of time. If your loan comes with such penalties, you will be locked into a fixed payment period.
Your Credit and Balance Transfer Cards
Instead of taking out a personal loan, many people choose to apply for a new credit card that has a credit limit that will fully cover their debt. Like a personal loan, this option has many benefits and drawbacks, too. The pros of balance transfer cards are as follows:
- Lower interest rates: Credit cards often have lower interest rates than those associated with personal loans. If you are an excellent credit consumer, you may even be able to obtain a card that has a zero percent APR. A lower interest rate will make it easier to pay off the debt, increasing your credit score as you do.
- Flexible payments: The payments you make to a credit card are typically more flexible than those that come with a loan. You can generally make payments when you want, and pay as much as you want. As long as you make the minimum monthly payment, it will not hurt your credit.
- No prepayment penalties: The prepayment penalties that come with personal loans do not apply to credit cards, so you can pay more when you are able, increasing your credit score.
Of course, using a balance transfer card also has some disadvantages. If you use close to the limit of the new card, your credit utilization will go up, which may cause your credit score to drop temporarily. As you continue to pay off the new card, your credit score will eventually increase again. It is also crucial that you understand the APR because if you do not, you may have to pay interest on any debt you do not repay before the introductory rate runs out.
Our Debt Defense Lawyer in Florida Can Help with Your Debt
Debt consolidation is very beneficial when trying to avoid lawsuits and get ahead financially. Unfortunately, they do not always work and you may still find yourself facing legal action from a creditor or debt collector. When that is the case, a Florida debt defense lawyer can help. At Loan Lawyers, we have defended against thousands of debt collection lawsuits, and we can build a strong case for you, too. Call us today at (954) 523-4357 or fill out our online form to schedule a free consultation and to learn more about how we can help.
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Loan Lawyers is made up of experienced consumer rights attorneys who use every available resource to develop comprehensive debt solution strategies. Our goal is to take on those burdens, resolve those problems, and allow our clients to sleep soundly knowing they are on the path to a better future.
