There are two main types of debt consolidation: debt consolidation loans and balance transfer credit cards.
Debt consolidation loans
Debt consolidation loans are a type of personal loan that you can use to pay off your existing debts. You’ll receive a single monthly payment with a set interest rate and repayment period. This can help you simplify your monthly payments and reduce the overall interest you’re paying on your debts. However, it’s important to note that debt consolidation loans can have a negative effect on your credit score if you don’t make your payments on time.
Balance transfer credit cards
Balance transfer credit cards are another option for consolidating your debts. With this type of card, you’ll transfer the balances of your existing credit cards to a single account with a lower interest rate. This can help you save money on interest and simplify your monthly payments. However, balance transfer credit cards can also have a negative effect on your credit score if you don’t make your payments on time or if you exceed your credit limit.
Debt Consolidation and your Credit Score
If you’re struggling to keep up with multiple debt payments each month, you may be considering debt consolidation as a way to get your finances back on track. But what effect does debt consolidation have on your credit scores? Let’s take a look.
Paying Off Debt improves your credit scores.
One of the biggest misconceptions about debt consolidation is that it will hurt your credit scores. But the truth is, if you’re consolidating high-interest debt into a lower-interest loan or line of credit, you’re actually doing yourself a favor in the long run. Not only will you save money on interest payments, but paying off your debt can also lead to an improvement in your credit scores. That’s because one of the biggest factors in your credit score is your “credit utilization ratio.” This is the amount of revolving credit you’re using divided by the total amount of revolving credit you have available. So, by consolidating your debt and paying it off, you’re actually improving your credit utilization ratio—which will give your credit scores a boost over time.
Taking out a new loan can temporarily hurt your credit scores.
Of course, there is one potential downside to consolidating your debt: taking out a new loan can cause a small temporary dip in your credit scores. That’s because when you apply for a new loan, the lender will do a hard inquiry on your credit report—which will cause your scores to drop a few points. However, this dip is usually only temporary; as long as you make all of your payments on time and keep your balance low, your scores should rebound within a few months. In fact, once you consolidate and pay off your debt, you may even see an improvement in your scores over time thanks to that lower credit utilization ratio we talked about earlier.
Conclusion:
If you’re considering consolidating your debts, it’s important to weigh the pros and cons carefully. Debt consolidation can help you simplify your monthly payments and save money on interest, but it can also have a negative effect on your credit score if you’re not careful. Make sure to do your research and speak with a financial advisor before making any decisions.
