Debt consolidation loans have become popular among people entangled in a mire of debt, hoping to get rid of financial obligations and tidy up their credit records. Be careful though because although this debt relief program can bail you out of debt and restore your credit score, it also has the potential to damage your finances and credit rating. How the program will affect your credit will highly depend on how you manage the debt consolidation loan.
The Immediate Effect of a New Debt Consolidation Loan
Expect a modest decline in your credit rating each time you get a debt consolidation loan, or any new loan for that matter. Several factors come into play when determining your credit score. How many new loans you open is one of these. One new loan will have a minor impact, but your score may significantly decline if you open a number of credit card accounts at the same time obtain a debt consolidation loan. Credit inquiries can also slightly hurt your score and applying for a new loan would always lead lenders to inquire about your credit record.
The Impact of Closing Accounts
A debt consolidation loan involves using the proceeds of the loan to pay off other financial obligations. For instance, you can obtain a home equity consolidation loan to settle several of your credit card accounts. Once you do this, do not close all of your accounts right away even if you do not have any balance anymore. This is because your credit card score also hinges on the number of years that you have maintained your accounts; the longer, the more favorable for your score. Additionally, closing accounts also influences your credit utilization ratio. This is the amount of debt you have vis-a-vis your credit limit. The lower your credit utilization ratio, the more favorable for your credit score. Once you close your accounts after paying them off, you are passing up on huge credit available for you. This increases your total credit utilization ratio, and negatively affects your credit rating.
How a Debt Consolidation Loan Can Raise That Score
When taking out a debt consolidation loan, make it your goal to gradually decrease debt. The impact of taking out a new loan on your credit score is only secondary to your ability to make your monthly payments. Remember that you consolidate your debts by taking out a new loan because this new loan offers a lower interest rate, hence, also decreasing your monthly payments, which in turn makes them more affordable for you. This allows you to pay on time, thereby steadily decreasing your debt. This will boost your credit score.
The Effect of Missing Payments for Your Debt Consolidation Loan
Some people fall into the temptation of using the extra funds they obtain from a debt consolidation loan, or the savings they get from the new loan due to the lower rate and monthly payments, to buy other things and eventually lead them to default on their payments. This will definitely injure their scores. Expect a drop between 60 and 100 points in your score when you fall behind for 30 days in your payment. A greater damage will result if you are many more days late in payments and your creditors sue you or sell your account to collections agency.