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How Debt Consolidation Affects Credit Rating

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Are you struggling to pay your bills?  Have more monthly payments than you can afford? If you are overwhelmed with debt, you may be considering consolidating.  While debt consolidation has a lot of advantages, there can be some disadvantages as well, which is why you should consider working with a debt professional to guide you through the process.   You have many professionals to choose from such as debt settlement companies and debt attorneys.

What is debt consolidation?  This is the process of taking multiple debts with different lenders and putting them into a single loan with one creditor.  There are several different ways to achieve debt consolidation and all have their upsides, however each has the potential to adversely affect your credit rating:

Home equity loan: If there is equity in your home, you may be able to take out a loan to pay off your existing debt and consolidate.  The benefit of this is that home equity loans typically have much lower interest rates than traditional loans.  With this type of loan you use your home as collateral so if you default on the loan, the bank takes your home.  While the lower interest rate may be tempting, it may not be worth risking the roof over your head.  A home equity loan will appear on your credit report and will look a lot like credit card debt.  While this additional liability does ding your credit score you can minimize the damage by maintaining consistent, timely payments.

A new credit card: Depending on your credit score, income and other factors you may be able to get a new credit card with a high limit and put all your existing debt on that one card.  The temptation to use this option is that you may be able to get a great low interest rate by signing up for a new card.  The possible down side is that the low rate may only be for a short amount of time.  If you are unable to pay off the consolidated card within that short window of time your rate could skyrocket and end up costing you more money in the long run.  There is also a danger with this strategy that once your other credit cards have available room you may use them to make charges beyond what you can pay off every month.  This leaves you with more debt and more money problems.  Your credit rating will also probably drop with this plan.  Assuming that your new credit card has a $30,000 limit and you consolidate all your other debt onto that card, taking up $28,000 of your $30,000 available credit; this gives you a poor utilization rate.  Your utilization rate looks at the available credit for each credit card debt and what percentage of that available credit you have taken.  Ideally, you want keep your utilization debt for each credit card below 20%.

A bank loan: You can consolidate your existing debt in a bank loan, secured or unsecured.  To obtain a secured loan you will need collateral such as a car.  An unsecured bank loan is extended to you based on your credit worthiness.  If you are already having financial difficulties and don’t have collateral or a healthy credit rating these may not be available options for you.  A bank loan can impact your rating negatively as it is reflects another debt that you are responsible for.  However, if it gives you the opportunity to catch up on payments you can slowly improve your rating over time.

Regardless of which form of consolidation is right for you, there are some basic ways that debt consolidation can impact your overall credit.  Keep these in mind when strategizing with your debt professional:

  1. Whenever a credit inquiry hits your report it causes a dip in your credit score
  2. A high balance on any credit card will also cause a drop
  3. Interest rates don’t appear on a credit card report so they don’t directly impact your credit one way or the other.
  4. Some debt consolidations will require you to be delinquent on your payments which will have negative credit consequences
  5. If you leave your other credit cards open once you have transferred the balance it can increase your total available credit and improve your score
  6. If consolidation allows you to get a lower interest rate and you apply any savings to your debt, you are able to pay off your debt more quickly and improve your credit rating.

Debt consolidation can be incredibly helpful when trying to get a handle on your finances.  It can simplify your payments and loan terms and ease the stress of trying to deal with multiple bills every month.  Consolidation may also be the answer to achieving lower payments, making your debt more manageable.  Debt consolidation does impact your credit rating, but even if it is for the worse, sometimes this may be a necessary choice to get your debt under control.  Once you are able to meet your obligations you can focus on improving your credit if necessary.

Many people face financial challenges but the important thing is to be proactive in resolving the situation.  A debt attorney can assess your specific situation and review your options with you.  If you are in need of assistance, please call us at 855-976-5777.  Together, we can find a workable debt solution.

How Debt Consolidation Affects Credit Rating was last modified: October 30th, 2016 by Kevin Fallon McCarthy
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Kevin Fallon McCarthy is the McCarthy Law PLC’s managing attorney and an experienced Phoenix debt attorney. Mr. McCarthy has also worked as general counsel for a large corporation. He has corporate counsel experience in human resource matters, general corporate governance, and union class action litigation.
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