When it comes to managing multiple debts, people have numerous alternatives available to choose from. One of the alternatives is a debt consolidation loan. So, every information-seeking person would ask the question – Does debt consolidation hurt your credit?
When considering debt consolidation as an option, there is a common misunderstanding about its effect on your credit score. Meaning that because debt consolidation is usually used when you are in worsened financial health, then it should have a negative impact on your credit score. But in reality, the impact is positive. By taking a debt consolidation loan, you are repaying all of your existing debts. The credit agencies are recording this action as you have paid all of your debts. Which, in reality, is true. Afterward, the debt consolidation loan appears as a new loan on your credit report.
Moreover, having a debt consolidation loan eases the process of managing your finances. This is so in a sense that you have only one monthly payment, which is much easier to be paid. Compared to multiple payments on multiple debts. If you miss a payment when having multiple debts, your credit score could go down. For that reason, in the long run, a debt consolidation loan will positively affect your credit score unless you are a financially irresponsible person and start missing payments on your consolidation loan payments. Then, it will negatively affect your credit score.
Although the debt consolidation loan, by itself, does not have a negative effect on your credit score, the loan application process could have a slightly negative effect on your credit score. Meaning that the effect, or lack of it, depends on the type of inquiry that your lender will perform, a hard inquiry or a soft inquiry. When applying for a loan, the lender will almost always perform a hard inquiry.
For this reason, keep in mind that every loan application is followed by a credit check. This means that, when applying for a debt consolidation loan, your creditor could perform a hard inquiry. This hard inquiry will have a minor negative effect on your credit score. Thus, speaking about the effect arising from debt consolidation loans on your credit score, it does have a minor negative effect. But, this negative effect would be removed from your credit record after a couple of years.
On the other hand, if you don’t pay the monthly payment on your consolidation loan, it will have a negative impact on your credit score. Keep in mind that a debt consolidation loan does not relieve you from debt. It merges all of your payments into one single payment. Thus missing your monthly obligation towards your creditor will have a negative effect on your credit score.
Moreover, another circumstance where a misunderstanding might appear, and result in a drop in your credit score, is related to your activities after you have taken a debt consolidation loan. Meaning that you could be blaming the debt consolidation for your decreased credit score, where, in reality, it is your fault, not the consolidation loan.
For instance, if you continue to use your credit cards or continue to build debts, then you will negatively affect your credit score. The reason is that you could be missing your monthly payments for the purpose of paying the minimum on your credit cards.
If you want to go a step further, then make sure that you are aware of the effect of the debt consolidation alternatives on your credit score. For instance, debt management plans – will have a negative impact on your credit score. This is so because your plan will direct you to repay your debts by making smaller repayments. Since you are not paying the full monthly amount, it will negatively impact your credit score. Moreover, debt settlement – will also have a negative effect on your credit score because it means that you have not repaid the full amount of what you owe to your creditors. In addition, filing for bankruptcy –is yet another alternative that will have a negative effect on the credit score. It will show on a credit report for 7 to 10 years.
Taking a debt consolidation loan could negatively impact your credit score solely because of the hard inquiry performed during the application process. It is not because you are using debt consolidation. This negative effect would be there, regardless of the loan you will apply for. This is so because each lender performs a hard inquiry before granting you a loan. So, it is not the debt consolidation that should be blamed. Instead, it is the normal procedure for obtaining a loan.