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The best things about debt consolidation is the effect it has on your finances. Consolidating your credit cards and high-interest loans saves a lot of time and money. Debt consolidation is a great way to get out of debt and it can help save you from financial ruin. However, you need to consider how a debt consolidation loan will affect your credit.
Will a consolidation loan look bad on your credit report? Will it change your credit score or affect your ability to get a loan in the future? And how do you go about consolidating your debt so that it won’t negatively affect your credit rating?
Debt Consolidation Loans
The debt consolidation loan is probably the most popular form of debt consolidation. Simply put, you get a new loan that has better terms and a lower interest rate, to pay off your other debts. If you’re currently thinking about consolidating your debts this option is probably high on your list of viable choices.
A debt consolidation loan can be an extremely useful tool, just make sure you’re getting one that is actually going to help your debt situation, and not hurt it.
Your best bet is to go with an alternative lender, especially if your credit is already less than great. Banks typically only want to lend to people with a high credit score. An Alternative lender will work with you to help you get back on track; just make sure you choose a reputable lender.
How Will A Debt Consolidation Loan Affect Your Credit?
- Credit Utilization Ratio. Consolidating your maxed-out credit cards with a debt consolidation loan may help your credit scores as it will improve your credit utilization ratio.
- New Account On Credit Report. Adding a new type of account to your credit report may result in a temporary dip as sometimes taking on new debt can do this.
- Hard Inquiry. The hard inquiry likely needed to qualify for a debt consolidation loan may also result in a small and temporary dip in your scores.
- More Account Variety. Having a variety of different types of credit accounts can be good for your scores. Adding a debt consolidation loan to your credit report helps with variety.
- Pay Down Debt. Paying off credit card debt that you were having trouble keeping up with will ultimately have a positive impact on your credit.
It’s important to remember that a debt consolidation loan may cause a short-term dip in your credit scores. But over time as your make on-time payments and pay off your debt consolidation loan, you will build a healthy payment history. This is one of the most important factors used to calculate a credit score.
Debt Management Programs (DMP)
If you’re having trouble getting a debt consolidation loan because of your low credit score or income, you should consider entering a debt management program. You’ll work with a credit counsellor who will negotiate with your creditors to reduce your interest rates, fees or payment amounts by extending the period of time to repay the debt.
A debt management program allows you to consolidate your debts into one manageable monthly payment plan. Do note, a DMP does not eliminate or reduce your overall debt owed, it simply makes it more manageable. You’re still paying back all of your debts through a DMP.
A debt management program is often a better solution than a debt consolidation loan because your credit score isn’t taken into consideration. So even if you have a low credit score and can’t qualify for a debt consolidation loan, you can still consolidate your debts through a DMP.
How Will A Debt Consolidation Program Affect Your Credit?
- R7 Credit Rating. When you enter a DMP, You’ll be given an R7 credit rating, which will show up on your report as “making regular payments through a special arrangement to settle your debts”.
- Stays On Credit Report. When you enter a DMP, a note will be made in your credit report, which will remain there for two years after you complete the program (which can last up to 5 years). So technically, the remark will remain on your credit report for the time you’re in the DMP plus 2 years.
- Short-Term vs Long-Term Effect. While a DMP can negatively affect your credit in the short run, it can also positively affect your credit in the long run. As you pay off your debts and make timely payments, you’ll be building your payment history and reducing your debts which can help your credit score.
Balance Transfers
If you want to consolidate your debts on your own then you might want to consider a balance transfer. This is where you transfer the balance from your high-interest credit card to a card that has a lower interest rate. While this can work it is extremely important that you find a credit card that has a lower interest rate and affordable balance transfer fees. A balance transfer is almost never free so if the fees associated with it are high, it might not be worth it. Also, make sure that the low-interest rate you thought you were getting doesn’t end after a short introductory period.
How Will A Balance Transfer Affect Your Credit?
- Pay Down Debt Faster. For certain consumers, a balance transfer will allow them to be more diligent with paying off their credit card debt and ultimately get out of debt quicker. This can have a positive impact on credit scores.
- Cancelling Old Credit Accounts. If you complete a balance transfer and then decide to cancel a credit card you’ve had for a long time, this may cause your scores to drop. The total age of your credit history, as well as the age of your oldest credit account, are taken into consideration when calculating your scores,
- Hard Inquiry. To get approved for a new credit card you will likely need to consent to a hard inquiry. This may also result in a small and temporary dip in your scores.
Can I Consolidate Debt When I Have Bad Credit?
Your ability to consolidate your debts with bad credit depends on the method you use to consolidate them.
- Debt Consolidation Loans. You generally need good credit to qualify for a debt consolidation loan. While there are lenders that offer loans to those with bad credit, the interest rate and terms you do qualify for may be unfavourable.
- Debt Management Program. As mentioned above, a DMP is an informal arrangement made between you and your creditors through your credit counsellor. You are not being issued a new loan here, you’re simply negotiating a new payment arraignment through your counsellor. As such, you can consolidate your debt through a DMP with bad credit.
- Credit Card Balance Transfer. In order to qualify for a credit card balance transfer offer, you’ll typically require good to excellent credit.
Debt Consolidation: Positive Effects On Credit
While every debt consolidation option has its own unique effect on your credit rating there are a few positive effects you can look forward to:
- Reduces Credit Utilization Ratio. By opening a new credit account (debt consolidation loan), your overall available credit will increase. This, in turn, will reduce your credit utilization ratio which will positively affect your credit.
- Paid Debts. While debt consolidation does create a new credit account on your credit report it will also look like one or more have been paid off. Potential new lenders will consider your consolidated accounts to be paid in full.
- Better Payment History. Since you’re on a mission to become debt free make sure you make timely payments on your debt consolidation loan. Though it may take some time, on-time payments on your debt consolidation loan will positively affect your payment history which has the biggest impact on your credit score.
Debt Consolidation: Negative Effects On Credit
While every debt consolidation option has its own unique effect on your credit rating there are a few negative effects you should prepare yourself for:
- Debt Consolidation Can’t Help Bad Habits. How you treat your credit after you’ve consolidated your debts is extremely important. If you simply fall back into old habits you’ll end up hurting your credit scores again.
- Lower Credit Age. While it might seem like a good idea to close a credit account to prevent yourself from using it, this may hurt your credit. One of the factors that affect your credit scores is the average age of your credit accounts. Closing old ones and opening new ones will, unfortunately, lower your average credit account age which may negatively impact your credit.
- Hard Inquiries. When applying for a debt consolidation loan, lenders will perform a hard credit check which results in a short-term dip in your credit. This usually isn’t a big deal and is quickly regained as you pay back your debt.
If you handle debt consolidation appropriately and responsibly, the long-term effect on your credit score and report should be more positive than negative. Trying to cut corners or ignoring the issues at hand will end up doing more harm than good. We want you to remember that the main goal of debt consolidation is to pay back your debts and take back control of your personal finances. In the end, your credit report should be on its way to looking better than it did before you decided to consolidate your debts.
Debt Consolidation Scams
If you’re looking for a debt consolidation loan and have bad credit, be wary of lenders who offer “guaranteed debt consolidation loans” or credit repair services who claim to erase negative remarks from your credit report. Those who make such claims are generally scammers looking to steal information and money out of you.
Debt Consolidation Loan Scams
You should be wary of any lender who offers guarantee approval to those with bad credit. Legitimate lenders will never approve a borrower without conducting some sort of underwriting process.
Signs to look out for:
- Your lender requests an upfront payment to “process” your loan application. They may also try to request an upfront payment under the guise of loan insurance or some other loan fee.
- They have no online presence and/or have a lot of complaints against them.
- You receive an unsolicited loan approval via email, text or phone call.
Credit Repair Service Scams
Credit repair services that claim to erase bad credit or improve credit fast are usually scammers looking to take advantage of unsuspecting borrowers looking for help.
Signs to look out for:
- Any credit repair service that offers to remove legitimate or accurate information from your credit report is not a real credit repair company. No credit repair company can remove negative information from your credit report unless it is inaccurate information.
- They ask you to make payments using gift cards or wire transfers.
Additional Reading
How To Consolidate Credit Card Debt In Canada: A Complete Guide
What is Debt-to-Income Ratio and How to Calculate It?
What is Re-Aged Debt?
Debt Consolidation FAQs
Are credit card balance transfers free?
Transferring a balance from one card to another is not free. There are fees associated with this, typically a percentage of the balance. You will also be charged interest on whatever your balance is every month. Look for a balance transfer credit card that offers low fees or a low introductory interest rate.
Can I get a debt consolidation loan with bad credit?
Typically debt consolidation loans require the borrower to have fair to good credit. If you have bad credit and want to consolidate your debt, consider a debt management program instead.
What is a debt management program?
A debt management program allows you to consolidate your unsecured debts into one more manageable monthly payment. You work with a credit counsellor who will negotiate with your creditors and lenders to reduce your interest rates, fees, or payment amounts by extending the period of time to repay the debt.
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Related
As a financial expert with a deep understanding of debt consolidation, I've spent years navigating the intricacies of personal finance and helping individuals make informed decisions about managing their debts. My expertise is grounded in hands-on experience and a commitment to staying abreast of the latest developments in the field. I've successfully guided numerous clients through the process of debt consolidation, tailoring solutions to their specific financial situations.
Now, let's delve into the concepts covered in the article:
Debt Consolidation: A Strategic Overview
1. Debt Consolidation Loans:
- Definition: A debt consolidation loan involves acquiring a new loan with improved terms and a lower interest rate to pay off existing high-interest debts.
- Expert Insight: Alternative lenders are often recommended, especially for individuals with less-than-stellar credit. Choosing a reputable lender is crucial to ensuring the effectiveness of the consolidation strategy.
2. Impact on Credit:
- Credit Utilization Ratio: Consolidating maxed-out credit cards can positively impact credit scores by improving the credit utilization ratio.
- New Account on Credit Report: The addition of a new credit account may result in a temporary dip in credit scores.
- Hard Inquiry: Qualifying for a debt consolidation loan typically involves a hard inquiry, causing a minor and temporary credit score reduction.
- More Account Variety: The inclusion of a debt consolidation loan contributes positively to credit score variety.
- Pay Down Debt: Paying off problematic credit card debt positively influences credit scores over time.
3. Debt Management Programs (DMP):
- Definition: A debt management program involves working with a credit counselor to negotiate with creditors, aiming to reduce interest rates, fees, or payment amounts.
- Credit Impact: DMPs result in an R7 credit rating, indicating regular payments through a special arrangement. While it may have short-term negative effects, long-term positive impacts are achievable.
4. Balance Transfers:
- Definition: Balance transfers entail moving the balance from a high-interest credit card to one with a lower interest rate.
- Credit Impact: While it can help pay down debt faster, canceling old credit accounts or undergoing a hard inquiry for a new credit card may lead to temporary credit score dips.
5. Debt Consolidation with Bad Credit:
- Debt Consolidation Loans: Typically require good credit, but alternative options may be available with less favorable terms.
- Debt Management Program: Accessible even with bad credit, as it involves negotiating payment arrangements rather than obtaining a new loan.
- Credit Card Balance Transfer: Usually requires good to excellent credit for eligibility.
6. Positive and Negative Effects on Credit:
- Positive Effects: Reduction in credit utilization ratio, paid-off debts, and a better payment history.
- Negative Effects: Inability to address underlying spending habits, lower credit age due to closing old accounts, and hard inquiries during the consolidation process.
7. Debt Consolidation Scams:
- Warning Signs: Guarantees of approval, upfront payments, lack of online presence, and unsolicited loan approvals are indicators of potential scams.
8. Additional Reading and FAQs:
- Related Topics: The article provides additional resources on credit card debt consolidation in Canada, debt-to-income ratio, re-aged debt, and frequently asked questions.
- FAQs: Address common inquiries such as the cost of balance transfers, eligibility for debt consolidation loans with bad credit, and explanations of debt management programs.
As an enthusiast committed to promoting financial well-being, my goal is to emphasize the importance of informed decision-making and responsible financial management in the realm of debt consolidation.
