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More and more American households are in a fix and end up needing a credit card refinancing. Their credit cards and loans continue to accrue alarmingly high balances, forcing them to look for a number of creative strategies to repay their debt.
One of the most effective methods to repay your debt is known as debt consolidation. Debt consolidation allows you to combine all your accounts in a single place, and more importantly, allows you to take advantage of a lower interest rate.
But, not all is roses with debt consolidation, and it has its fair share of flaws. Often, debtors wonder whether it’s possible to consolidate debt without hurting credit.
Impact of Debt Consolidation on Credit Score
In debt consolidation, you secure a loan on a lower interest rate in a bid to pay multiple credit card balances and loans that charge a hefty interest rate. Although your overall debt management remains the same, it becomes a lot convenient to pay off your debt with debt consolidation.
Unfortunately, debt consolidation does influence your credit score in the short run. When you go to take out a debt consolidation loan, such as a line of credit, home equity loan, or a personal loan, it causes certain development, causing your credit score to drop.
Hard Equity Is Carried Out
When you fill out a loan application, lenders launch a hard inquiry on your credit to assess your payment history. This way, your credit score loses critical points.
New Account Is Opened
After you receive the loan approval, you get to see a new credit account on your report. It causes your credit score to decline further.
Average Credit Age Decreases
One of the key metrics for your credit score is the average age of all your accounts. After you launch a new account, your average account is altered and can reduce your credit score.
Although it’s hard to see your credit score go down, particularly when you are looking to rebuild your financial position, debt consolidation is a good strategy to strengthen your credit score.
Lower Credit Utilization Ratio
One of the factors that make up your credit score is the usage of your available credit. When you apply for a new loan, your available credit balloons up and bring down your ratio. For instance, if you had a credit card having a $5,000 credit limit and owed $2,500, you have 50% credit utilization. You can lower your credit utilization by paying off this card and others like it.
Improve Payment History
After paying off your debt consolidation loan payments regularly, your credit scores climb up gradually. Keep in mind that payment history is the most important factor in the calculation of credit scores; therefore, it should be your chief financial priority.
Alternatives to Debt Consolidation Loans
If your primary objective is to wipe out all your debt without relying on a debt consolidation loan, you have a lot of options to choose from.
When you can’t have a loan approved due to a poor credit score, it’s a good idea to try out debt settlement. With this process, you work with a third-party settlement company that handles your savings account. All your payments are transferred to the account. Unlike before, you no longer pay directly to your creditors.
After a significant amount of savings have accumulated, your settlement agency reaches out to the creditors and puts up an offer on the table where they will pay a specific portion of the total debt while the remainder will be waived off. This approach is detrimental for your credit score, but it’s worth considering for those who are getting sucked into a debt trap. It could turn out to be a quicker method to wipe away your debt and set yourself on a path that takes you towards a better credit score.
Balance Transfer Credit Card
A balance transfer credit card defers your debt. Find a card that comes with a 0% promotional APR offer, especially the one with a longer duration. Such offers have a lifespan of 12 to 18 months. What this means is that your credit card balances are moved to your balance transfer card, after which you don’t have to pay interest until the introductory period concludes. Usually, there’s a charge – balance transfer fee – ranging from 2% to 5% of the total amount you are passing on to the card. For instance, if you are moving a balance of $10,000 at a 5% fee, you will be required to pay $500.
But, experts recommend this process only if you are confident that you can survive without relying on your credit cards and don’t have to take a new loan. Just like debt consolidation, this approach also affects your credit score after you create a new account. However, improving your credit utilization ratio and making regular payments will eventually help you strengthen your credit score.
Revise Your Budget
While revising your budget, you have two courses of action: either reduce your expenses or generate more money. And if you can do both, you can become debt-free in a short period. For instance, consider getting a more affordable streaming service to watch TV shows or reduce the number of dining outs. In order to supplement your income, you need to create another revenue stream, such as by trying freelancing or working for a temporary part-time job.
Debt consolidation undermines your credit score, but only in the short run. If you can make regular payments and avoid falling back into the debt trap, and generate enough income to pay for your minimum monthly payment, you can rebuild your credit score steadily.