Debt consolidation can save you if you are drowning in debts. With debt consolidation, all your loans are combined into a single loan so that you only make one payment every month. In addition, the new loan now also carries a lower APR interest rate.
However, you may be saying wouldn’t applying for a new loan to consolidate your debts to reduce your credit score. That is true because the creditors will make a hard inquiry on your credit history in order to find out whether you meet the requirements for the loan. However, your credit score can slowly increase as you make on-time payment to your credit account. The payment history accounts for a big portion of the credit score so you should try your best to pay on time.
There are some lenders that require various accounts to be closed before approving the debt consolidation loan which can lead to a drop in the credit score. The reason is that doing so is increasing the credit utilization ratio and reducing the available credit balance. So, you should be checking with your lender to see if there is any requirement to close your accounts. Debt consolidation can improve your credit mix and subsequently increase your credit score if you take out not many loans in the past.
Conssolidating Debts Is A Great Step Towards Financial Freedom
Debt consolidation does not make your debt disappear or reduce the amount you owe. If you don’t make the payment on time, it will still affect your credit score in a negative way. To ensure you make a payment on time, you must make up your mind not to simply waste money and budget your money to spend on only the things you need to buy. If your credit score is too low, you can try improving your credit score first before applying for the debt consolidation loan.
When your credit score is raised, you can apply for a debt consolidation loan with a lower interest rate. You may not be able to pay for the loan on time if it has a high-interest rate. Another reminder is that you should look for a loan that does not have any prepayment penalty if you plan to pay it in full before the end of the loan term.
Sometimes, it makes more sense to postpone in consolidating your debt. For example, you plan to make a large purchase and you believe you can get your credit score to reduce if you wait for a bit longer. In this case, you should consolidate your debt after your credit score decrease and you buy the car. On the other hand, you can also postpone in consolidating your debt if you feel you have to wait for a little longer to develop good money management habits.
Written By Lisa Jackson, MBA
University of Phoenix School of Busines