Debt Consolidation can make it easy for you to manage finances by combining multiple debts into one account and making a single monthly payment. But along with this ease comes a question of great concern: Does debt consolidation hurt your credit score?
A brief answer to your question is: Debt consolidation does have the potential to drop your credit score in the short term, but not necessarily hurt your credit score in the long term.
By making payments on time, debt consolidation may improve your credit score eventually. This impact on the credit score is defined by the type of consolidation, how you apply, and what you do after the consolidation.
In this blog, you will get to know everything about debt consolidation and its impacts.
What is Debt Consolidation?
In debt consolidation, your different debts, whether they are credit cards, personal loans, or other debts with high-interest rates, are combined into a single loan. Now, instead of paying debts separately, you will make a single monthly payment for the consolidated debt.
In Canada, the common debt consolidation options are:
· Debt consolidation loans
· Personal loans
· Credit cards
· Home equity loans
· Home equity lines of credit
· Personal lines of credit
Debt consolidation doesn’t mean that your debt is eliminated; it just restructures your repayment while reducing the interest you pay.
Does Debt Consolidation Hurt Your Credit Score?
Debt consolidation doesn’t hurt your credit score automatically. There are always two faces of a coin.
If we see one side of the coin, then you will see a temporary decline in your credit score after applying for consolidation because applying for a new consolidation may result in a hard credit inquiry.
Here comes the other side of the coin.
It is stated by the Financial Consumer Agency of Canada that debt consolidation can enhance your credit score if you make payments on time and reduce the number of accounts with high balances.
How Debt Consolidation Can Affect Your Credit Score?
1. Applying for a new credit inquiry
The lender may perform a hard inquiry when you apply for a new credit, which can impact your credit score negatively. So you should carefully compare the available options before submitting multiple applications.
2. Opening a new credit account
When you open a new loan or credit account, it affects the average age of your credit accounts, which affects your credit score temporarily.
3. Keep credit utilization lower
Credit utilization refers to how much of your credit is currently being utilized.
For example, if your credit card limit is $1000 and you have an outstanding balance of $800, then your credit utilization is 80%. Credit utilization is used by creditors to determine your level of risk.
If your credit utilization is higher, then you look risky from the perspective of lenders. So, it is suggested by the Financial Consumer Agency of Canada to use 30% or below of your available credit.
Lower credit utilization means a healthier credit profile.
4. Payment History
Good payment history will increase your credit score, while missed payments will decrease your credit score. Loan consolidation will make it easy for you to pay off the loans by paying a single loan rather than several loans and also build good payment history.
5. Closing old credit accounts
Closing old credit accounts can shorten your credit history and reduce the available credit. Thus, it is not necessary that you immediately close every account after paying off the credit cards.
When does Debt Consolidation Make Sense?
Debt Consolidation makes sense when you have debts with high-interest rates and have multiple monthly payments that are difficult to maintain.
This will create a structured monthly repayment schedule for you if your income is stable enough to manage the new monthly payment.
It is necessary to consider interest rates, fees, loan term, period and total repayment amount besides the monthly payment in the process of consolidation.
When Debt Consolidation Can Hurt Your Credit?
1. You made multiple credit applications
Applying for several credit applications to lenders can result in multiple credit inquiries that can result in temporarily lower your credit score.
2. Missing payments
Late or missed payments can negatively impact your payment history and lower the credit score.
3. Closing Old Accounts
Closing old accounts after payoffs can shorten your credit history as well as your credit score.
4. Taking new loans
If you continue using your credit card even after consolidation of debt, you may end up with more debt than before.
5. Unaffordable monthly payments
If the new consolidated repayment is difficult to manage, then missed payments can hurt your credit score.
6. Use of Home Equity without repayment plan
Using a home equity loan for consolidating debt can put your home at risk if you can’t keep up with repayments.
How to Apply for Debt Consolidation?
Compare the different options available for debt consolidation and then follow the steps.
Review your current debt
Create a list of your current loans, credit cards, interest rates, and monthly payments to know how much you need to consolidate.
Check your credit report
Review your credit score before applying, as this will help you to know the consolidation options you are eligible for.
Compare consolidation options
Compare different consolidation plans for their interest rates, time period, total cost, and then choose a suitable lender instead of applying to multiple lenders.
Submit the application
After comparing and choosing a suitable lender, submit your application with all needed information like identification and proof of income, details of existing debt and other financial documents.
Use the funds to clear the existing debts
If your application gets accepted, use your consolidated loan to clear the existing debts.
Make on-time payments
Once your debts get consolidated, make every payment on time to protect your credit score from getting hurt and avoid accumulating new debts.
How EverLend Helps With Debt Consolidation Solutions?
Are you looking for debt consolidation solutions through mortgage refinancing and equity in your home? EverLend can provide you with some mortgage solutions that would suit your purposes in terms of the type of financing that you need in order to accomplish your aims.
EverLend offers personalized mortgage financing services that would enable homeowners in Canada to be able to evaluate the different types of mortgages available to them. If you are not sure if it is a good idea to go for mortgage financing for debt consolidation, contact EverLend to discuss your options.
Conclusion
Debt consolidation is a financial tool that is helpful but not a fast method to get rid of your debts. Debt consolidation doesn’t eliminate your debts. It makes them more manageable, especially when you are dealing with high-interest debts.
So, before receiving a loan, please make sure you understand the interest rate, fee, payment term and total price of the loan you are about to receive. In addition, think about the impact on your credit score and the ability to manage finances after getting the loan.
If you want to use home equity or refinance to consolidate high-interest debts, you can talk to a mortgage professional, such as EverLend, to get informed about the options you have.
Frequently Asked Questions
Does debt consolidation really lower the credit score?
Debt consolidation can temporarily lower your credit score because of credit inquiries and opening a new account, but it improves your credit score in the long run.
How long will debt consolidation affect my credit score?
There is no set timeframe in which the score will recover. It can improve by making payments on time.
Is debt consolidation a better choice than using credit cards individually?
Maybe. With a low-interest rate, it might be a better choice. It is important to do some calculations before coming to any conclusion.
Can debt consolidation improve my credit score?
Yes, it might. Reducing the credit usage and making payments regularly might help improve the credit score.
Should I close my credit cards once I have done credit consolidation?
No. It isn’t a wise thing to close old credit cards.