How Does Debt Consolidation Affect Your Credit Score?
Nobody likes to be in debt. Thankfully, there are plenty of solutions to debt in the modern age of financial products. One of the most popular options is debt consolidation.
However, the world of finance is complicated. Many people rightly worry about how different financial decisions will affect their credit score. That’s why we put together this helpful FAQ. We’ll cover the different ways that debt consolidation, specific kinds of debt, and other kinds of debt relief can affect your credit.
Use this information to make smart financial decisions. After all, planning is the key to financial success. Understanding how different debt solutions affect your credit score is essential if you’re going to be able to accurately plan your finances.
Debt consolidation is an effective way to get out of debt fast. Moreover, it allows you to get out of debt while spending less money that you would without consolidation.
Debt consolidation works by taking your current balances and paying them off with a single credit card consolidation loan. This loan effectively consolidates your debt into one place. As a result, it’s easier to keep track of payments, see the progress you’ve made, and manage your finances.
Another advantage of debt consolidation is that it usually has a lower interest rate than your current loans. That has several advantages. First, your monthly payments will be lower. That saves you money immediately. Second, you’ll pay less in interest over the course of repayment. That saves you money in the long run.
Given these facts, it’s not hard to see how debt consolidation is an attractive option for many people. However, there are some questions about how consolidating debt can affect your credit score. This section will provide answers to those questions. Use it to decide if debt consolidation is the right solution for you!
How Does Debt Consolidation Affect Your Credit Score?
Debt consolidation has multiple impacts on your credit score.
That’s because there are lots of different factors that go in to your credit score. You’ll see an initial slight dip in your score from the hard inquiry you need to get approved for debt consolidation. You’ll also see a dip because any time you get a new credit or loan product, your score goes down. That’s because seeking and obtaining these products sends the signal you might have money problems.
However, if you use your debt consolidation loan wisely, then your score will go up much more than the initial drop. That’s because you’ll be utilizing less of your available revolving credit. You can do this if you refrain from using the credit cards that you consolidated with your loan. Credit utilization makes up 30% of your credit score. Therefore, lowering your credit utilization and making on-time payments on your consolidation loan will cause a dramatic improvement in your score.
Be careful though, it’s easy to do more damage. If you consolidate your credit cards and then immediately start using them and don’t pay off the balance, then you’ll find yourself in a much worse situation than before.
Do Debt Consolidation Loans Affect Your Credit?
Debt consolidation loans affect your credit in several ways.
The overall impact of debt consolidation loans on your credit is determined by how you act after you get the loan. You’ll see a slight dip in your score at first. That’s because you’ve opened a new account and had a hard credit inquiry.
However, you’ll see your score go up after that. This is because you’re not using as much of your available revolving credit. It will also go up as you make on-time payments on your consolidation loan. As long as you don’t start leaving a balance on your credit card accounts, you’ll continue to see your credit score improve.
Does Consolidating Credit Card Debt Hurt Your Credit Score?
There are two answers to this question, in the short term and in the long term.
In the short term you’ll see a slight drop in your score. That’s because of the new account and the hard credit check needed for approval.
In the long term your score will go up so long as you don’t leave a balance on your credit cards again. That’s because your revolving debt is consolidated into installment debt with the loan. As a result, you’re not utilizing as much of your revolving debt. That accounts for 30% of your credit score, and allows you to see fast gains.
Other Debt Solutions
There are lots of other debt solutions people can try. We’ll cover how those affect your credit score here. Use this info to decide what the best option is for your particular financial situation.
How Does Debt Relief Affect Your Credit?
Debt relief can mean a lot of things. You’ll need to find out what specific debt relief methods the company you’re working with uses. We’ve covered debt consolidation in the previous questions. Debt settlement will hurt your credit score. That’s because you’re not paying as much as you said you would. That shows creditors and lenders that you’re a higher risk for default.
Many debt relief efforts can help your credit score. That’s especially true if part of your agreement with your lenders involves how they report your actions to the credit reporting agencies.
Will Settling Credit Card Debt Affect My Credit Score?
Yes, as long as your creditor reports that the debt was settled for less than owed you will see a drop in your score.
That information will stay on your credit report for 10 years. Settling a debt causes a credit score drop because the company gave you the loan or line of credit under the assumption that they’d see a certain amount of profit. Debt settlement means they don’t see as much profit or may even take a loss.
As a result, this information shows that you’re at a high risk of not paying back future loans and lines of credit. That lowers your score and makes lenders less likely to approve applications.
How Will Debt Settlement Affect Credit?
Debt settlement will cause a drop in your credit score.
Lenders and creditors offer you financial products with the expectation they’ll be paid 100% of what you owe plus the interest. When you settle for less than that amount, it shows lenders and creditors that you’re at a higher risk of defaulting on your debt obligations. If the company reports the settlement to the reporting agencies, and the almost certainly will, that information will lower your credit score and stay on your report for 7 years.
How Does a Debt Management Plan Affect Your Credit?
Simply being in a debt management plan doesn’t affect your credit score.
But your debt management plan will be noted on your report. As long as your debt management plan is active, you won’t be eligible for new loans or credit.
Additionally, one of the primary actions of a debt management plan is to close your current accounts. That lowers the average age of credit history on your report. In turn, that will lower your score. It also affects your credit utilization rate and cause your credit score to take another hit.
Over the long term, making on-time payments to your debt management plan will increase your score. That allows you to rebuild your credit score over the course of repayment. By the time your debt management plan is paid and you’re eligible for new loans and credit products, your score will likely be much higher than it would have been without the debt management plan.
Specific Types of Debt
People also ask a lot of questions about how specific types of debt affect their credit score. Frequently, they’re doing this to decide if a debt consolidation loan is worth it or not. This section answers some of the most common questions people have about specific kinds of debt and their credit score.
Does Medical Debt Affect Credit Score?
Medical debt does not by itself affect your credit score.
However, it can cause serious problems for your score if you fall behind on your payments or default on the debt. That can result in being sent to collections, which can have a huge negative impact on your score.
How Much Does Debt to Income Ratio Affect Credit Score?
Your debt to income ratio doesn’t affect your credit score in any way.
That’s because your credit report and credit score doesn’t include your income.
This is a common misconception. That’s because lenders and creditors ask what your income is when you apply for a loan or line of credit. They’ll get your debt obligations from your credit report and see what your debt to income ratio is. Therefore, your debt to income ratio can influence whether or not you get approved for a loan or line of credit, but it doesn’t actually affect your credit score.
Does a Debt Collection Affect Credit?
Yes, debt collection has a serious negative impact on your credit score.
Debt collection stays on your credit report for 7 years. A collections effort shows that the original creditor wasn’t able to collect the money you owed. They had to charge off that debt and take a loss on your loan or line of credit. That shows that you’re at a higher risk for default on other credit products and lowers your score.
How Does Debt Affect Credit Score?
This is a complicated question to answer. By itself, debt doesn’t necessarily affect your credit score.
However, that can change depending on what form the debt takes. Credit card debt affects your credit score based on what your debt is versus how much credit you have available. This is called credit utilization, and it makes up 30% of your credit score.
Debt can have a positive impact on your credit score if you pay your bills on time. These successful payments will be reported to the credit reporting agencies and will boost your score. However, if you can’t make your payments or fall behind, then your credit score will suffer as a result.
Does Student Debt Affect Credit Score?
Student debt does not affect your credit score by itself.
That’s because it’s a type of debt known as installment debt. Your credit score isn’t affected by the overall amount of installment debt you have. What matters is your history of payments on that debt. Making on-time payments will cause your score to climb. However, missing payments or defaulting on the debt will have a serious and negative impact on your credit score.
While student loan debt doesn’t directly affect your credit score, it does affect your debt-to-income ratio. That can influence your ability to get other loans or lines of credit from creditors. However, this is distinct from your credit score. Consider looking into student loan debt consolidation.
Can Credit Card Debt Affect Your Tax Return?
Standard credit card debt in good standing cannot affect your tax return.
However, if you settle your credit card debt for less than you owe, the difference may be counted as income by the federal government. That income will affect the amount of taxes that you owe, and thus will affect your tax return.
As you can see, there are lots of different ways that debt, debt consolidation, and other debt relief options can impact your credit score. Moreover, other types of debt don’t usually impact your credit score negatively as long as you pay your bills on time. The one exception to this is credit card debt. That’s because credit card debt is revolving debt. As a result, it affects your credit utilization, which makes up 30% of your credit score.
Use this information to make smart financial decisions about how to pay off debt fast. It’s almost always better to take a small credit hit for consolidating debt if it means that you’ll avoid the larger negative impact of late and missed payments and defaults that can occur if you don’t consolidate your debt. Talk to a financial planner or advisor or check out our other articles if you have more questions about debt, credit scores and debt payment options.
Carl has years of experience helping people tackle debt. As a Senior Financial Advisor, he knows the ins and outs of debt consolidation and debt management. He holds a Masters Degree in Finance and according to him, not all debt problems are the same and that’s why it’s important to take a look at the different options available for your situation.