Debt Consolidating & Credit Score: What You Should Know
If you are nursing multiple high-interest loans or have credit card dues, making monthly payments can be quite challenging, and you may struggle to save money. In such a scenario, it is quite natural that you feel stressed about your finances. However, you can easily get out of this situation and ease the financial burden by opting for debt consolidation.
However, you get started with it, and you must have a clear understanding of what debt consolidation is, how it works, and its impact on your credit score.
What is debt consolidation, and how does it work?
Debt consolidation is a facility offered by financial organisations that allows you to combine all your loans/dues into a single one and pay off the amount with a single EMI (equated monthly instalment) instead of making multiple monthly payments.
It is considered to be an excellent debt management strategy, allowing you to stay on top of all your debts and manage your finances better. Also, when you consolidate your debt, you may be able to get a lower interest rate, which, in turn, may help you save a lot of money on interest payments in the long run.
How does debt consolidation affect your credit score?
When you opt for debt consolidation, you essentially pull several levers that may harm your credit. And here are a few short-term causes of why you may see a drop in your credit score when you review your credit report.
When you apply for a debt consolidation loan or a balance transfer of credit cards, the new lender will initiate a hard inquiry into your credit profile, and this may temporarily lower your credit score by a few points. Once you start repaying the amount, the score will slowly improve over time.
Note: Crif doesn’t penalise your credit score for a hard inquiry.
As you opt for debt consolidation, you essentially open a new credit account. From a lender's point of view, a new credit is a new risk, and this may cause your credit score to dip by a few points.
One of the important things you must know about debt consolidation impact on credit score is that a new credit account lowers the average credit account age, and it may temporarily lower your credit score. However, as your credit account gets old and reflects on-time payment, your credit score will automatically rise.
However, debt consolidation impact on credit score is not always only negative. Here are some positives for your credit score from debt consolidation.
When you transfer credit card balance to a new card or culminate all the loans into one by means of debt consolidation, your credit utilisation ratio may go lower. It is essentially the ratio of total credit available to you and the credit amount you are using. This may result in improving your credit score.
It may take some time, but if you make your payments online at the time of the new debt consolidation loan, you may see your credit score rise slowly. So, it is paramount that you make the payments on time to improve your credit standing.
Different ways to consolidate your debt
The crux of debt consolidation is to merge different credits or loan balances into one single loan. However, not all debt consolidations are good from a prudent financial planning viewpoint. Here are a few ways to consolidate your loan based on your savings and credit.
• Personal loan
If you can avail yourself of a personal loan with a lower interest rate, you can easily pay off all the high-interest loans or credit card dues and be debt-free. This, in turn, may have a positive impact on your credit standing and credit score.
Also, you may have to worry about only one EMI instead of multiple payments. So, the chances are less that you may miss making any payments, and you can further avoid a hefty penalty.
• Balance transfer credit cards
Some credit card companies offer a balance transfer card, which you can use to transfer the dues on another card to this new card. Also, when you apply for a balance transfer card, the credit card company may offer you an introductory offer, which charges a lower interest or no interest on the balance you transfer for a specific period.
This may give you a chance to save on the interest payments, and you may take advantage of the situation to pay more than the minimum EMI amount and pay off the debts faster.
• Make a budget and stick to it
Another effective strategy for debt consolidation is to make a budget and adhere to it. Make sure that you don’t overspend and possibly incur more debt than you can afford to pay off, which in turn may hurt your credit.
• Consider getting a secured credit card
Nowadays, credit is not a luxury item but a necessity. But, when you are on a mission to rebuild your credit score, it is advisable that you avoid applying for a traditional credit card and instead opt for a secured credit card.
As the name says it all, banks issue secured credit cards against the deposit you hold with them, and the credit limit of the card is usually equal to the deposit amount. This makes it a viable credit card option for you as you have a low credit score.
As you use this card and make regular payments, i.e., pay off the full amount each month, over a period, your credit score will automatically improve. So, when you are looking for ways on how to make credit score right, make sure to apply for a credit card that aligns with your credit requirements and current credit standing.
Conclusion
Consolidating debt is a great way to manage debt and ease the burden of repayment. It allows you to repay all outstanding loans and credit card bills with a single payment, and you may possibly get to repay the amount at a lower interest rate than before.
However, when you opt for debt consolidation, you must be wary of its effects on your credit score; it may take a hit and affect your credibility as a borrower. But, as you continue to repay the amount, you can slowly get the credit score back up.
So, do your due diligence, understand the pros and cons of debt consolidation and make an informed decision accordingly.
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