Can a Debt Consolidation Loan Hurt (or Help) Your Credit Score?
Exploring the right strategy to consolidate debt without impacting credit scores
Interest rates at all-time lows. So, paying off your high-interest debt with a low-interest debt consolidation loan may be a smart move, especially if you’re only making minimum payments on credit cards or other bills. Debt consolidation loans can be used to pay for medical and credit card bills, student loan payments, and even other loans that you secured at a higher rate.
How Do Debt Consolidation Loans Work?
Debt consolidation allows you to merge several unsecured debts into one low monthly payment at a lower interest rate. That’s the promise, but unfortunately, it’s not always what happens. That’s because debt consolidation loans are offered by lenders or creditors, and rates and terms will likely depend on your credit score and credit history. Even if you qualify for a low-interest loan, there’s no guarantee the rate will stay low. Besides, debt consolidation loans often extend the term of the loan, so you may end up actually paying more in the long run.
That said, debt consolidation loans can be a good thing if you’re up to your ears in debt, you’re paying unreasonably high interest, or you just can’t make all your payments. Even with extended terms, your one monthly payment will likely be much less than multiple payments at a variety of interest rates.
Why Consider a Debt Consolidation Loan?
It’s not uncommon to have many debts – credit cards, medical bills, student loans – all accruing interest charges. For instance, credit cards can carry double-digit interest, making it easy for card balances to spiral out of control.
It can also be difficult to keep track of multiple due dates, not to mention wondering each month if you have the money in the bank to cover each amount owing. If you fall behind on your payments, it can hurt your credit score, and you’ll rack up unwanted fees and late charges.
Another advantage of a debt consolidation loan is that it is a good way to pay off everything you owe. That’s because the loan has a predetermined payoff date. You make monthly payments, and at the end of the term, your debt is paid in full.
Pros and Cons to Debt Consolidation Loans
Using a debt consolidation loan to manage your debts can have both positive and negative consequences.
Pros of Debt Consolidation Loans
A lower interest rate means more of your payments are going toward your principal balance each month, so you’re making a bigger dent in your total debt.
You make one monthly payment rather than several payments, which makes it easier to stay on budget.
Simplifying multiple payments into one payment makes it more difficult to accidentally miss a due date.
There's the potential for both a lower interest rate and lower monthly payments than you're paying now.
Consolidating your debt helps you pay off older debts, which can raise your credit score over time.
Cons of Debt Consolidation Loans
Because with a debt consolidation loan you make only one payment, you might be tempted to spend more.
You might not always get a better interest rate, or the rate might not always stay the same over the term of your loan.
Most debt consolidation loans are secured, so you may lose your collateral if you default on your loan.
The term of your loan will likely be longer, so it will take you more time to pay off your debt.
Most loans charge some fees, like processing or origination fees, but some debt consolidation loans come with higher than normal fees and charges. It pays to shop around.
Initially, your credit score will take a hit. But, it is a short-term effect and your score should improve over time.
Kathryn Pomroy is a journalist and writer specializing in personal finance, consumer banking, credit cards, and loans. She has written for LendingTree, Money Crashers, Quickbooks/Intuit and Bankrate.
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