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Does Debt Consolidation Hurt Your Credit Score?

A person looking over a receipt, balancing their personal finances

Living underneath a crippling pile of debt can be a difficult burden to bare.

A recent 2018 survey found that lack of financial stability was the number one cause of stress in Americans.

Debt consolidation can be a path towards financial freedom if you take the proper steps along the way. The problem is many people are afraid to work with debt consolidation companies because they’ve been told by the lending community that their credit scores will be negatively impacted over many years and it may never recover. 

The truth is debt consolidation can, in most cases, actually improve  your credit score and financial situation by paying off your debt and showing that the tradelines were paid in full for less than the balance owed on your credit report

What is Debt Consolidation?

Debt consolidation is a strategy utilized to combine all of your unsecured debt into a single monthly payment. It can be accomplished as an unsecured personal loan or debt resolution. With an unsecured personal loan lower interest rates with more favorable terms will allow you to pay down your debt obligations while saving money in accrued interest costs. If you are unable to qualify for debt consolidation under a personal loan, then working with the debt collector is the preferred solution. Debt consolidation as solution is offered at 0% interest and $0 down because instead of interest costs fees are charged as a percentage of the debt enrolled into the debt resolution option. However, fees are only paid to the company after your debt has been paid off and resolved with your creditors. With debt resolution, your unsecured debt from credit cards, personal loans, medical bills, collections and other unsecured loans is usually reduced to about 70% of your original debt balance and what was owed to your creditors and that includes the fees charged by the debt resolution company.   

Although credit scores may initially decrease while beginning debt consolidation as debt resolution, graduation from the solution generally results in an overall higher FICO score.

Most individuals believe a temporary drop in credit is worth paying off large amounts of debt Especially when they have no need to take on more debt during the period they are enrolled in debt resolution.

What Banks Think of Debt Consolidation

Banks often attempt to shed a negative light on debt consolidation companies. It’s in the banks best financial interest to keep consumers in debt to them as long as possible. Banks tend to promote the false belief that debt consolidation and debt resolution will significantly injure  a person’s credit score either permanently or over many years, but again keeping borrowers in debt and receiving interest payments is how they make their money.

The bank’s narrative couldn’t be further from the truth as debt consolidation is an appropriate remedy for solving many financial shortcomings. 

Let’s take a look at how credit is affected by debt consolidation and what impact this has on debt payoff.

How Debt Consolidation Affects Credit Scores

If you’re concerned about a temporary drop in credit scores, you should consider whether or not you need access to your credit in the next year or two.

While in debt resolution, people will not be able to take on debt for approximately 1 to 2.5 years. During this period they should be focused on paying off debt so that their credit will rebound and improve beyond their initial starting point. 

Borrowers should be asking themselves, “Do I really need access to credit to take on more debt in the next couple of years or do I want to end my debt burden once and for all?”

If you do not plan on making substantial purchases such as a home or car, debt consolidation is the smartest path to take. Excessive unsecured debt often prevents people from making these major purchases in the first place because of debt-to-income restrictions.

Let’s introduce Michael.

Michael fell victim to financial woes after encountering some unfortunate personal circumstances. Let’s look at how Michael could use debt consolidation in the form of debt resolution to improve his financial situation.

  • Michael enrolls his unsecured debt into a debt resolution solution and begins with a 680 FICO score.
  • Initially he goes into default on the unsecured debt and his credit rating drops to a 525 FICO score.
  • A resolution is obtained three months later for less than the balance owed and his FICO score improves to 575.
  • After completion of debt resolution, Michael’s FICO score improves to 730. Eliminating unsecured debt results in an increased FICO score and a very low debt-to-income ratio,, which now gives him access to the best interest rate and payment term options available for the purchases that matter most- a new home or vehicle.

As you can see, debt consolidation can be a financial lifeline for individuals looking to overcome debt.

Why Consolidate Debt?

Debt consolidation can save you money and allow you to pay off your debt much quicker. Credit card debt balances or unsecured loans with high interest rates can be consolidated into a new personal loan at a lower interest rate with more favorable payment terms or into debt resolution. 

For example, if you are only making the minimum payment of 2.5% of the balance on $20,000 in credit card debt at 21% APR, then it will take you 468 months (39 years!) to pay off your debt. In that time, you will pay $45,068.42 in interest charges. That is a total of $66,068.42 paid to the bank on $20,000 in credit card debt.t can also make life easier by simplifying payments. Having a single monthly payment is easier to manage than several monthly payments that can be difficult to keep track of and pay on time. 

Long Term Effect of Debt Consolidation

Although debt consolidation may temporarily impact your credit score, it can actually improve your credit utilization rate. This rate is based on credit currently used versus total credit available.

Pretend you have $10,000 available in total credit, but have a balance of $7,500. Your utilization rate is 75%. Paying off this debt would lower your debt-to-credit utilization ratio, which in turn should increase your credit score and allow you to qualify for better interest rates and terms on major purchase like a home or car.

Making consistent payments on time will also benefit your credit rating. Payment history plays a key role in credit scores, so making payments on time is of vast importance. 

Just be sure not to rack up more debt as you’re attempting to pay it off. Your end goal should be to pay off your debt as it will provide better financial flexibility for your future — Debthunch can help you get there.

Let Debthunch Provide You with Financial Freedom

At Debthunch we’ll quickly analyze your financial situation and provide you with the right debt consolidation solution for you. Simply fill out a short online application and we’ll match you with the best offers available for debt consolidation as a personal loan and as debt resolution. Review and compare your offers and accept the right debt consolidation based on your individual needs.

Quit making minimum monthly payments that could take decades to payoff. Hop on the path towards financial freedom with Debthunch today.

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