Managing debt from multiple creditors can be a tricky balancing act, especially in today’s challenging economy. Finding the best way to consolidate debt without hurting credit scores has become a top priority for many.
With many available options, it is crucial to understand each strategy to ensure you’re making a choice that best suits your financial situation. Read on to learn more about the debt consolidation process so you can make a more informed decision.
What Is Debt Consolidation?
Debt consolidation involves taking multiple debts and merging them into one. The ultimate goal is to streamline the repayment process while potentially securing a lower interest rate that reduces your monthly payments.
Lenders will perform a credit check to assess your creditworthiness and determine the interest rate. Once approved, you use the funds from the new loan to pay off your existing debts and consolidate everything into one easy-to-manage monthly payment.
Best Options to Consolidate Debt Without Hurting Your Credit
There are three main options to consolidate debt that can potentially leave your credit intact—and even improve it over time.
A personal loan is one of the most common methods of merging multiple debts into one. You’ll often get a structured repayment plan with a lower interest rate. However, the actual rate will vary depending on your creditworthiness.
Home Equity Loans
With a home equity loan, you can borrow against your home’s equity and use the money to pay off existing debts. The most significant advantage of this loan is the typically lower interest rate.
A balance transfer involves moving your debt from a high-interest credit card to one with a lower interest rate. Some credit card companies offer an introductory period with a very low or even zero interest rate.
However, the interest rate usually jumps up once the introductory period ends. Therefore it’s essential to pay off the debt within this period to maximize its benefit. Otherwise, you could get yourself even deeper into debt.
Does Debt Consolidation Hurt Your Credit?
Consolidating your debt can impact your credit score based on several factors, including:
Hard Credit Pulls—Applying for credit results in a hard inquiry on your credit report, and these inquiries can slightly reduce your credit score temporarily. According to FICO®, the impact is generally minor and lasts only 12 months.
Establishing a New Account—Consolidating debt decreases the average age of your credit accounts. This can briefly dent your credit score due to the effect on your credit history length. However, as this account ages (and you avoid opening new ones unless necessary), your average account age will rebound over time.
Increased Utilization—Consolidating credit card debt via a balance transfer card could be problematic if the new card’s credit limit is lower than the original one. Higher credit utilization ratios can negatively impact your credit score.
Remember that despite the temporary dip, your credit score can improve over time. For example, making timely payments will positively contribute to your credit history, which is an essential factor in determining your FICO® Score.
Impact of Debt Settlement and Bankruptcy on Credit
Debt settlement is when you negotiate with creditors to pay off a portion of your debt, often substantially less than what you owe. This strategy may seem appealing, but it has significant negative consequences for your credit score.
Creditors will mark a settled debt as “settled” or “paid settled” on your credit report rather than “paid in full.” This indicates to potential future lenders that you only paid back part of the amount you originally owed, which can be a red flag.
Bankruptcy is a legal process that helps those who cannot pay their debts by liquidating assets to repay creditors or creating a repayment plan. However, bankruptcy has one of the most severe impacts on your credit score.
There are two main types of personal bankruptcy: Chapter 7 and Chapter 13. Chapter 7 bankruptcy involves liquidating assets to repay debts and stays on your credit report for ten years. Chapter 13 bankruptcy, on the other hand, establishes a 3-5 year repayment plan and remains on your credit report for seven years.
Who Should Consolidate Debt and When?
Debt consolidation makes sense if you’re juggling multiple high-interest debts. It’s an excellent strategy if you have strong credit, which can help you qualify for the best rates on a consolidation loan.
However, if your debt is too substantial or your credit score is too low, you may not qualify for low enough interest rates to make the process worthwhile. In this case, consider exploring other debt-relief options.
With that said—there’s no better time than now to consolidate your debt. The longer you wait, the more interest you’ll wind up paying. Juggling multiple creditor repayments every month can potentially lead to a missed payment and lowered credit score.
Navigating Through Your Debt Consolidation Journey
Debt consolidation can be an effective tool that offers a path to financial freedom for those who qualify. Jeanne D’Arc Credit Union has a wide range of options to help you consolidate your debt and potentially save money through lower interest rates.
You’re not alone on this journey—so let’s conquer your debt together. Click below to learn more.