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Debt Consolidation Loans: Minimum Credit Scores Required

Elizabeth Johnson

Financial Advisor
Updated: 01/2019

Debt Consolidation Loans: Minimum Credit Scores Required

Debt consolidation loans and the debtor’s credit score share a symbiotic relationship. One simply cannot function without the other. Getting a loan with a poor credit score is just not easy.

Any debt consolidation lender will insist that the credit score of a prospective debtor should at least be between 620 and 640. Of course, some lenders agree to give out loans even when someone with a credit score as low as 580 approaches them but will definitely charge a higher rate of interest.

How your credit gets affected by debt consolidation

Debt consolidation can affect your credit depending on the multiple options you make a choice from. When you go for a credit card or a loan, you actually apply for fresh credit which means a “harder” inquiry into your personal credit. As and when this happens, your score dips.

A word of advice here: Before applying for loans to pay off debt, ensure you know your credit score which can be done online for free. This can be determined without actually impacting your personal credit report. There are sites that offer credit score updates on a monthly basis, credit monitoring for free, protection against identity theft, and mortgage options.

A debtor’s credit score also depends partly on his or her credit utilization – the debt amount he or she carries as compared to the net debt amount available to him. If it so happens that all their credit cards have maxed out, taking a new one increases his available debt while also causing their utilization ratio to dip, and that could work in their score’s favor.

However, it also needs to be known that their score will inevitably fall anytime they carry a hefty balance on any one of their cards. Thus, if multiple balances are transferred to one single card, and the credit limit is reached, their score stands to suffer even though they may pay off the debts outstanding pertaining to other cards.

If one consolidates their personal loans to repay their credit card debts, their utilization ratio is likely to dip, causing his or her score spiral in turn. In order to make this work, a debtor needs to leave their credit card accounts open after paying them off. However, their credit rating could fall if an underwriter raises a concern that they could have new debt on their balance-free and if they open up new credit cards as has been seen in many cases.

Protecting your credit

If you consider resorting to the services of a debt consolidation company, be informed first. For a nominal fee, it will negotiate with all your creditors to lower interest rates and/or balances on your behalf. Tremendous and reliable debt relief organizations usually obtain an agreement in writing from all your creditors that detail the terms and conditions of the said agreement, your own obligations and the reportable data to all concerned credit bureaus.

In case your balances are reduced, the creditor is at liberty to report a charge-off or bad debt, which negatively impacts your credit score and history. Also bear in mind that any debt relief agency generally charges a higher rate of interest than a mortgage lender or bank, particularly in cases where your credit isn’t exactly stellar. Moreover, this may reduce your savings in future once the fees are factored in.

However, should your credit score still be high enough, say, above 640, a credit card consolidation loan from an online lending platform or bank could spare you the higher interest rates and killing monthly bills. The only way to deal with a credit score below 640 is to consult a credit counselor or get into a DMP or Debt Management Program to regain control of your messed up finances. The added advantage is that any Debt Management Program may also function as a program for Debt Consolidation, devoid of the hefty interest payment.

How to Improve Your Credit Rating

If your credit score is not high enough to qualify for debt consolidation but feel that it is the best way for you to eventually become debt-free, you can try to improve your credit rating through these tips:

Look at your credit file

Because this is where your credit rating is based, it would do you good to make sure that all entries are accurate. You can actually request a free copy or pay a small fee to obtain it. If there are any discrepancies, you can dispute it with the credit bureau.

Leave your credit report as is

If you’re sure that there are no errors, leave it as it is. People think that having lots of items in their report will only dent their credit rating so they have it removed, but it is not. A debt is merely a basis of your credit score. In fact, good debts, those that you have successfully settled, actually reflect positively on your report because it means that you have diligently paid what you owe. Regarding those negative items that dent your credit score, you cannot do anything but wait seven years for it to disappear.

Disassociate from a financial partner

It could be your wife, your sister, or business partner. If they have a bad credit, it will rub off on you too. Thus, you do not have to follow this if you are a hundred percent sure your financial partner does not have a low credit rating or outstanding debts or has a credit score higher than yours because in that case, you are pulling yourself up.

Don’t miss your term payments

Most of the things you do related to your debts are reflected on your credit report. Yes, that includes missed or late payments. Such actions lead you to be viewed as irresponsible, unstable, and relatively riskier. Since you do not yet qualify for debt consolidation, the best you can do, at least until you do qualify, is to settle what you can for the interests not to compound over time.

Do not open new accounts too rapidly

This is not just because you are trying to get rid of your debts altogether. If you really need lines of credit to support your and your family’s everyday expenses, do not open them all at the same time because the average account age affects your credit score.

What are the things that affect your credit score?

  1. Total amount you owe – This accounts for 30% of your FICO score.
  2. Payment History – Accounting for 35% of your credit rating, this is also the hardest to remove on your score.
  3. Types of credit you use
  4. Length of credit history
  5. Newly opened accounts

Getting Rid of Debt Faster

Should you desire to free yourself of debt faster, it’s best to adopt the two-pronged strategy:

  • Make drastic changes in your monthly budget wherein you earn more and spend less. This would inevitably allow you to pay off more towards your debts on a monthly basis.
  • Reduce debt costs so that a larger portion of each payment that you make applies to your principal balance.

Given your particular situation, creditors may be willing to settle the debt for a percentage of the total outstanding amount. However, the reality is that relief from debts pertaining to credit cards can be tricky and also costly.

You first need to show that you are seriously in arrears. Subsequently, you need to convince all your creditors that you simply don’t have the funds to pay back your debt. Moreover, you have to declare that your financial condition won’t change in the foreseeable future either. However, if you go for a one-time debt settlement, the creditor will report the debt that has been forgiven to the Internal Revenue Service and it will be considered as taxable income.

The tax amount owed on the amount that has been forgiven will depend on the gross income that is adjusted and your personal tax rate. Even when you belong to a lower tax bracket, the IRS could slap you with a hefty tax bill.

The process of debt settlement involves long-term and hard-core attempts at debt collection by creditors and usually results in serious damage to any credit score lasting for a number of years.

Most debt consolidation agencies that work for a profit offer to help debtors through such processes, albeit for a substantial fee that eats into their savings. They usually instruct debtors to put a stop to monthly bill payments. This, however, leaves the debtor exposed to lawsuits that creditors may file against him for recovery of dues. An additional headache for a person with multiple debts is keeping track of so many bills.

However, it isn’t the number of cards you carry that matters to your credit-rating agencies. Rather, they are more concerned with your total debt volume on all cards concerned. According to figures published by the National Foundation for Credit Counseling, an average person who seeks credit counseling has 6 cards to his name, carrying a debt figure of $17,548 on an average.

The average rate of interest for most credit cards is around 14.95%. This, however, may spiral to a whopping 29% or even an eye-popping 79.9% for anyone with a bad or poor credit history. Moreover, every card has a different balance and due date. Should there be a default in payment, interest rates could rise and late fees could be imposed also. This usually leads to a situation where the debtor starts riding the treadmill and never gets off.

This is where a loan for debt consolidation works its magic by amalgamating all such bills into one solitary payment with a fixed rate of interest which is lower than fluctuating rates usually associated with credit cards.

Certain banks and numerous online lending platforms also offer consolidation loans. Here again, the terms depend largely on the credit history of the applicant. A majority of applicants for such loans first think of their individual credit scores, but lenders will scrutinize their debt-to-income ratio as well.

What is Debt-to-Income Ratio?

This ratio is calculated by adding all monthly debt payments and dividing the figure by a debtor’s gross income per month. For instance, say a debtor is paying $1,300 monthly for his mortgage, $400 monthly towards his auto loan and $500 monthly for other assorted debts while his pre-tax income per month is $5,000.

When the monthly debt of $2,200 is divided by his gross income of $5,000, the debt-to-income ratio works out to 44 percent. This proves problematic for lenders because a debt-to-income ratio that is above 40 percent usually spells trouble.

How Credit Scores Impact Interest Rates

Interest rates from lenders vary between 5.99% and 32.99% usually as also on other associated terms on the risk that a prospective borrower may not repay a loan. This is called “risk-based pricing,” and clearly supports the fact that lower risk will only garner better interest rates and loan terms. Thus, it may so happen that the “risk” may be too high to obtain a loan for consolidation. 695 is generally accepted as the average credit score but statistics show that nearly 19% of debtors have scores that are lower than 600, disqualifying them for consolidation loans. Use a debt consolidation loan calculator to see what your payments would be. However, there are other choices, particularly DMPs.

These loans are available from credit unions and banks for combining all your debts only. These loans vary in nature and call for careful selection, coming with lower interest rates than rates you are currently paying.

However, be careful that a bank may lower your monthly payment by increasing the total period of repayment. The agency for credit counseling also pays all participating creditors on the debtor’s behalf. The latter just makes a single monthly payment to the agency which is divided among his creditors in a manner already agreed upon. As payments continue to be made through a DMP, the debtor stands to start reestablishing their credit and pays off all his or her debts usually within three to five years.

Elizabeth Johnson

Elizabeth is an expert on Debt Consolidation as she provides helpful advice to people who are dealing with debt problems. She graduated college with a BS in Finance. After college, she took a job working at a non-profit debt counseling program. It was at this position where Elizabeth honed her expertise for helping people understand how different financial products work and finding ways to help people pay off their debts.