Consumers facing debt have to decide on the best solution to move forward to financial stability. One of those options is debt consolidation. How will consolidation affect a person’s credit? Let’s learn more about debt consolidation to improve credit.
Debt Consolidation to Improve Credit
Debt, missed or late payments, and a high debt to credit usage ratio can take a toll on a person’s credit- both credit history and credit score. These reports can be factored into all sorts of things, including future loans, employment and the ability to get low interest rates on cards. Since debt consolidation can improve a person’s finances, what is the impact on credit? Is debt consolidation to improve credit a viable solution for that issue?
What Is Debt Consolidation?
So what is debt consolidation? The exact meaning of consolidation is “the action or process of combining a number of things into a single more effective or coherent whole.” When loans or balances are combined, it makes a more effective and simpler repayment for the consumer. Debt consolidation is a way to help people whose debts are beyond their means or are so numerous that keeping track of payments is difficult. It is not a quick fix to solve debt problems.
One typical approach to debt consolidation involves taking out a loan. A new sizable loan replaces all the payments. Therefore, only one payment is needed as your other individual debts have been paid off with the new loan. The loan may be obtained through debt relief programs, your bank, or as a home equity loan.
A debt management program is a secure consolidation plan where a credit counseling agency consolidates your debt payments within the program. You will make one monthly payment for all of your unsecured credit card bills to the agency. They will then distribute your money to your creditors every month on your behalf which helps you plan monthly expenses and adhere to your budget.
Can Debt Consolidation Improve Credit?
Yes and no. The act of entering a debt consolidation program does not affect your credit score. However, many programs require that you close accounts. This means your credit utilization ratio will drop. As a result, your score will temporarily drop. Your credit will bounce back over time. Credit scores improve with on-time payments, positive and responsible use of credit and an appropriate credit utilization ratio.
It may take several months or years, but your credit score can look quite shiny and new again. In the meantime, a few months of positive payments is a great way to show you are moving forward and taking action to creditors.