Does Debt Consolidation mess with your Credit score?
The Covid-19 pandemic has been harsh on humanity. It has not only disrupted health but also affected employment status for many. The majority of the people are rebuilding their careers and businesses that went swaying away in the unstoppable storm of Covid waves one after the other. The unstable work situation landed many people in debt. So how does one deal with multiple debts piling up?
A debt consolidation loan is one solution to consolidate debts into one single monthly payment and get rid of multiple overheads. Debt consolidation is a helpful loan generally used to pay off previous loans and can offer several benefits such as lowering your interest rate, reducing your monthly payments, and becoming debt-free faster.
Debt consolidation can be a good option if you find difficulty paying your bills on existing credit cards or loans. First, however, you should analyse your financial background and plan for debt consolidation.
However, it is also necessary to be vigilant of how debt consolidation can positively and negatively damage your credit score.
How can Debt Consolidation mess with your Credit score?
Debt consolidation can have both good and bad impacts. Below listed are the ways how debt consolidation can mess with your credit score:
Hard inquiries on your credit
Whenever you apply for an instant loan, the lender will execute a hard inquiry to check your creditworthiness. Using a single credit will reduce a few points on your credit score, but availing of more than one loan or credit card in a short period will hurt your credit score.
Fortunately, several hard inquiries within a fixed period between 14 to 45 days get combined into one when your credit score is evaluated.
Credit utilization ratio
Your credit utilization is a measure of available credit that you are using at any time. Credit rating agencies check the credit utilization ratio, which should not exceed more than 30%. For instance, if you have a credit limit of Rs.6,00,000, your total outstanding on all the credit card ratios should not exceed Rs.2,00,000.
If your credit utilization increases after debt consolidation, it may severely hit your credit score. On the other hand, if you consolidate multiple credit card debts into a single personal loan, your credit utilization ratio and credit score will improve.
The average age of your credit account
Whether it is a new personal loan or a new balance transfer credit card, the average age of your account will decline and lower your credit score.
A prolonged tenure of your credit accounts and credit history – one filled with timely payments will have a positive impact on your credit score, and even by opening a new account, your credit score will turn out to be insignificant.
Payment history
Your payment history influences your credit score. A credit history reflecting timely payments will improve your credit score, and on the other hand, missed or delayed payments will see a drop in your credit score. Hence, be consistent in your credit payments.
Ways for debt consolidation
Here are various modes to consolidate your debt based on the outstanding credit and savings of the borrower:
- Apply for Personal loans –This is an ideal choice for consolidating your debts at a lower interest rate and pay-off higher interest credit card balances quickly and easily.
- Switch to balance transfer credit cards –You have the option of transferring your high-interest rate credit card or a new lender with a more affordable interest rate. Balance transfer credit cards offer low or no interest on balances that you transfer to the card during a set period.
- A home equity loan –A type of consumer debt that enables you to tap into your equity to gain access to funds. Homeowners can avail of a loan by keeping their home as security or collateral for consolidating debt. Usually, home equity loans are offered at low-interest rates compared to credit cards or personal loans.
- Opt for a debt consolidation loan –It helps to clear all your outstanding dues at once. It replaces multiple high-interest EMIs with one instalment at an affordable interest rate. In addition, this type of loan is more manageable as you have to handle one loan rather than paying multiple debts.
- Limit your expenses –Cut back on your costs and allot money towards paying debts instead. This method will also improve your credit score by managing your finances and monthly budget in order. It will showcase to the credit agencies that you are a responsible individual in credit repayment.
Bottom-line:
If you pay the debt consolidation EMIs on time and in a set tenure, your credit score will increase over the long run as you get rid of the debt faster and form a good repayment history.