In general, people who are in debt have 2 types of debts, i.e. secured and unsecured debt. When they decide for debt consolidation, it means their multiple debts are lumped together or combined into one debt. Currently, there are many debt consolidation companies in the market that promote debt consolidation service to assist people to get out from deep debt.
According to them, by consolidating all loans, their clients will be able to pay off their debts faster at a reduced total debt amount. However, these service providers do not inform that consolidating debt can AFFECT your CREDIT SCORE.
Before making any decision to consolidate your loans, first thing first, it is really important for you to know what credit score is and how it is evaluated. In United States, a credit score is a figure representing the creditworthiness of a person. In other words, it indicates the likelihood that a person will pay his or her debts. Then, let’s see how the credit score is made up of:
1. Payment History (35%)
2. Total Outstanding Balance (30%)
3. Age of Credit History (15%)
4. Types of Credit Used (10%)
5. Applications / Inquiries for New Credit (10%)
In fact, consolidating debt has quite big impact on your credit score, especially when your credit history, your new application and your total amount owed are evaluated. Take a closer look at the scenarios below:
- When you first consolidate your debts, you need to open a new account. This particular new account will lower the average age of your credit history.
- When you open a new account for consolidation purpose, it is important for you to write a letter to your lenders to request them to close your old accounts. If you don’t do so, your credit report will be stated that it is being closed by creditors. Your credit score will definitely be affected.
- When you are applying for a new loan, creditors will usually request to review your credit report. This will be listed as an inquiry. Too many inquiries on your credit report may reduce your credit score because the lenders may assume that you are borrowing more money than you will be able to pay back.
- Most of the time, when the debt consolidation companies are in the process of negotiation with their clients’ creditors, they will normally drag the payment until the negotiation process is completed. Late payment will be shown on the credit report and it will directly hurt the credit score.
In contrast, debt consolidation will not hurt your credit score in the long run if you are able to ensure that you are disciplined enough on your spending habits. After you have opted to consolidate your credit card debts or loans, NEVER EVER use the credit cards or turn your loans around anymore.
Once you get rid of your debts, STOP incurring additional debt in the future. If you manage to do so, you will be able to get your finances under control and you can actually move towards a better credit rating.
To sum up, debt consolidation can be an extremely helpful financial solution if you apply it intelligently. Choosing a good service provider to assist you is very important as the way they manage your debts determines your credit score.None found.