How Does Debt Consolidation Affect Your Credit Scores? Here’s What You Need to Know

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The American public is swamped with credit card debt. The average person has nearly $6,200 in outstanding credit card debt.

One of the problems with carrying credit card debt is high-interest rates. The average Annual Percentage Rate (APR) on a credit card is nearly 15%.

With an APR this high, consumers are paying hundreds, if not thousands, of dollars in interest per year. Debt consolidation is a great option for reducing interest expenses.

Many consumers question the impact debt consolidation has on a credit score. Read on to answer the question, does debt consolidation affect your credit? Explore other topics such as the benefits of debt consolidation.

What Is Debt Consolidation?

A high number of Americans have multiple lines of credit. It is not uncommon to see consumers have personal loans, credit cards, or even medical debt. This leaves individuals juggling multiple due dates and revolving accounts.

Debt consolidation provides consumers with a solution for this credit crunch. Here, a lender will cut a check to close out each outstanding line of credit. Next, they will bundle all the balances into a single account.

What Types of Credit Can Be Consolidated?

A debt consolidation program can accept many different forms of credit. Of course, the most common are credit card debt and personal loans.

However, a consolidation package can also absorb private student or business loans. Accounts that are in collection are often consolidated as well.

Many consumers are struggling with medical debt. In fact, 137 million Americans are negatively impacted by medical debt. This is another credit type that can be rolled into a consolidation.

What Are the Benefits of Debt Consolidation?

There are many benefits to debt consolidation. Perhaps most important is that you can reduce your monthly interest expenses. With the average APR nearing 15%, consumers often find a better deal under a consolidation package.

Another benefit is the gift of time. For consumers with multiple lines of credit, interest charges seem to strike every week or two. Now, you can create a monthly payment plan and prepare for a lower interest charge.

Those who choose to consolidate their debt also rave about the account management. It is much easier to plan around one payment per month. Consumers in debt are juggling multiple due dates and stressing whether they have enough cash to make payments.

How Is Your Credit Score Calculated?

There are three credit reporting companies; Experian, Equifax, and TransUnion. Each of these two institutions has a proprietary method for calculating credit scores.

High Impact

We do have a good idea of what factors drive a credit score up or down. One of the most important factors is whether you make on-time payments. Missing the due date on a payment is certain to drive your score down.

Any derogatory remarks on your account also drive the score down. These are items such as debt collections, bankruptcies, or tax liens.

Another major factor is a ratio of outstanding balances to the total credit limit. Credit reporting agencies do not like it when the ratio on an account is higher than 30%. The best credit scores typically keep an account at 10% or less.

Low to Moderate Impact

There are other factors that have less of an impact. First, there is the number of total accounts open or closed. Next, the credit agencies look at how many hard inquiries you have on your account. Each time a lender checks out your credit score, it has a negative impact on your score.

Lastly, another factor on your credit score is the age history. A short age history tells lenders that you are at higher risk.

Credit reporting agencies prefer consumers that maintain a credit line for a long time period. It tells them that you can be trusted over the long term.

What Is a Good Credit Score?

Credit scores range from 300 to 850. Anything above 800 is considered excellent and any lender will consider you creditworthy.

The vast majority of Americans fall between 600 to 750. According to Experian, two-thirds of Americans have a good credit score. This is any credit score than is 670 or higher.

Credit scores ranging from 580 to 669 are classified as fair. Roughly 17% of the American population falls in this category.

In the fair range, you can still get approved for a line of credit. However, you are likely to receive a higher rate and pay more in interest. You may also need to pay fees or make a down payment.

Does Debt Consolidation Affect Your Credit Score?

Applying for debt consolidation is certainly going to impact your credit score. When you apply for a new loan, every lender is going to check your credit. This will result in a hard inquiry, which has a low and temporary impact.

If you are approved for the loan, it will also affect your credit age history. Now, you will have a new loan on record with minimum repayment history. Again, this is a low impact and temporary factor.

A new debt consolidation loan increases the total number of accounts on your record. This is a positive change with a high impact.

Debt consolidation also affords you the opportunity to improve your on-time payment history. With only one bill per month, it is easier to manage your payments.

Perhaps most importantly is that you will eliminate accounts with a high balance to credit ratio. As you pay down the balance, your credit limit ratio also improves.

Each month that you pay down the loan’s principal results in credit score improvement. From a big picture perspective, taking out a consolidated loan can improve your credit score significantly over the long-term.

Wrapping It Up

Debt consolidation may be the first step in your journey to financial freedom. It is an effective way to reduce your monthly interest expenses.

Some are worried about consolidation’s impact on credit score. Over the long-term, however, it will help establish positive repayment history and a lower balance to credit limit ratio. If you are still wondering does debt consolidation affect your credit, contact us today for more information.

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