How Debt Consolidation affects Credit Score

Your credit score is one of the factors that determine which offers you will receive from lenders. It will help determine which lenders would accept or deny your loan applications. In addition to that, it will be one of the factors considered when determining interest rates they’d be willing to offer you.

When you’re struggling with debt, the way you choose to handle it will have a profound effect on your credit score. One of the ways people deal with overwhelming debt is debt consolidation. But debt consolidation loans have an interesting relationship with your credit score.

Let’s delve into the relationship debt consolidation has with peoples’ credit scores.

debt Might Drag Your Credit Score Down

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Could Debt Consolidation Hurt Your Credit Score?

First of all, applying for any kind of credit may slightly lower your credit score, sometimes it will only be temporary. Usually, the more credit you apply for within a short time, the more of an effect it will have.
In most cases, people who seek debt consolidation have a lengthy credit history in their recent histories. So yes, debt consolidation could hurt your credit score. This immediate effect is normally small and won’t last long, however.
The hit on your credit score happens when a debt consolidation lender makes a hard inquiry on your credit score. Hard inquiries normally lower your credit score by a small amount. However, if you use a debt consolidation loan as intended and pay on time every time, the net effect on your credit score should, at most times, be positive.

Personal Financial Habits
The more impactful effects that debt consolidation has on your credit score depends on how you use your loan. If you use debt consolidation for credit card debts, then use your renewed credit limit to go on a big shopping spree, you’ll be worse off than you were before you got a debt consolidation loan. However, using debt consolidation responsibly and with a plan is more likely to yield better results.
The best way to make debt consolidation end up improving your credit score is to use a reliable debt management plan. This way you can ensure you get the most out of debt consolidation.

 

How Can Debt Consolidation Help Your Credit Score?

Debt consolidation can help your credit score in the short term and the long term.
In the short term, using debt consolidation to clear all your other debts quickly can cause an immediate boost in your score. Clearing individual debts improves your credit score, but it does it slowly. 
In the long-term, if your debt consolidation loan allows you to pay back your other debts, your score can increase over time. Debt consolidation loans are single, large loans taken to pay several smaller debts back. Ideally, they offer a lower interest rate than the combined interest you’re paying for your other loans.

 Payment History
One of the most important factors that contribute to your credit score is your payment history for all your credit accounts. When you have multiple debts, especially with histories of missed payments, your credit score drops.
Debt consolidation improves the payment history aspect of your credit score. Payment history is the most significant credit score factor. So, you can greatly increase your credit score over time if you choose debt consolidation and then pay your new loan back.

 

How long does Debt Consolidation stay on your credit report?

Like other personal loans, debt consolidation loans stay on your credit report for a set timeframe. Your debts are not removed from your credit report the moment they are paid off. Settled accounts remain on credit reports for seven years after the time of settlement.
So, what is a “settled account”? A settled account is one where a lender agreed to accept less than the full balance owed. This can be negative because when you have settled debts, it means you did not pay your debt back in full as per your original contract. But settled debts are still far better than outstanding debts or those closed due to bankruptcy. That’s why many lenders are more than happy to settle debts.

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How do different types of Debt Consolidation affect your credit score?

There are several types of debt consolidation. They do not have an equal effect on your credit score. Debt consolidation is provided differently for different types of debts. These types of debt consolidation differ in how they’re viewed by credit reporting bureaus.

 Medical Loans Debt Consolidation

 If you’re using a payment plan from your healthcare provider, medical loan debt consolidation won’t be reported to the 3 major bureaus. The 3 major bureaus, Equifax, Experian, and TransUnion, agreed to exempt medical accounts on credit reports until a debt is over 180 days past due. Veterans are protected from certain medical debts being reported to bureaus until a year after a procedure. Also, medical debts have a lower impact on your credit score than other debts.

Consolidating medical debt may remove these protections. If you decide medical debt consolidation makes sense for you, consider the protections afforded to you. It’s up to you to decide whether medical debt consolidation is right for you.

Student Loans Debt Consolidation

The federal government and some private lenders offer student loan debt consolidation. Of course, you can only be eligible if you have more than one student loan.

You can consolidate student loans through the Department of Education for free. If you go through a private lender, they will often need a hard pull on your credit score, causing a small, temporary drop. The same factors listed above will be in play. But if you start making your new payments in full and on time, your credit score might start to rise over time.

Business Loans Debt Consolidation

Combining several business loan debts with debt consolidation is likely to raise your credit score. If you continue making full and timely payments on your debt consolidation loan, your credit score can rise over time. 

Credit Card Debt Consolidation
Paying off a large portion of your credit card debt may improve your credit score. Repayments in any amount over the minimum will incrementally improve your credit. Just remember to leave your credit card accounts open. If you make the mistake of closing your accounts shortly after consolidating your credit card debt, you will lose out on the benefits and your credit score will drop

Use a table to include the different types of debt to consolidate:

Debt Consolidation Type Things To Consider
Medical Loans debt consolidation
  • Many types of medical debt carry especially low interest rates.
  • If you consolidate your medical bills your account may no longer be classified as a medical bill account because the debt will now exist in a loan or credit card account.
Student Loans debt consolidation
  • Consolidating a student loan to a lower interest rate can decrease the amount you will owe overall. However, this might not be the case when consolidating federal student loans.
  • Once you consolidate your student loan, you’ll have more time to pay your loan back. 
Business Loans debt consolidation
  • Business debt consolidation could provide relief if you find a low-interest loan that can replace several high-interest loans. 
  • Business debt consolidation loans would allow you to combine multiple outstanding balances into one loan balance. 
Credit card debt consolidation
  • You may be able to improve your credit score if you pay off a large chunk of your credit card balances.
  • Credit scores don’t account for your income. So even if you can afford to max out your card, it still might have a negative effect on your credit score.
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