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With money as tight as it's ever been in the United States, many people are frantically looking for ways to pay off their debts and save few bucks. If you are one of them and hunting for the right type of debt help, which won't affect your credit score in any way, then you are simply building castles in the air. Every debt relief plan would hurt your credit score in some way or the other. Debt consolidation service is no exception, but it has a relatively lower impact on your credit. The effect of debt consolidation on your credit rating depends largely on your behavior after you receive the loan.
Debt consolidation
Some consolidate their bills in order to have only one monthly payment instead of several, while others consolidate their loans in order to lower their monthly payments or lower the interest rate on debts. The most obvious benefit, that debt consolidation offers is it helps you to reduce the number and the amount of payments you make each month and thereby make it easier to avoid late payments that can sabotage your credit score. It also helps you to save money if the interest rate of your loan is less than the interest rates on your credit cards. Lastly, with consolidation your credit cards are paid off, but your accounts remain open, allowing you to access your credit if necessary. However, loan consolidation can have an adverse impact on your credit score as well. Read on to know more in this regard.
Credit Score
In order to understand why consolidation lowers your credit score, one first needs to understand the factors used for determining a FICO score. The list includes your payment history, the amount of money you owe, the ratio of your debt to your available credit, the length of your credit history and the number of new credit lines you open. Debt consolidation can affect some of these factors considerably.
Debt-to-Credit Ratio
Thirty percent of your FICO score depends on the amount of money you owe and your debt-to-credit ratio. This ratio looks at how much money you owe on a line of credit versus how much money is still available to you. It implies that the less of your available credit you use, the higher your overall credit score becomes. For example, if you borrow $10,000 to consolidate all of your credit debts, then you have used the full $10,000 line of credit available to you from this source which indicates you are using 100 percent of this available credit line. If you previously had two credit cards with a $10,000 limit and you owed $5,000 on each, then it denotes with consolidation you have changed your debt-to-credit ratio from a 50 percent to a 100 percent. This affects your credit score to some extent.
Average Age of Credit Accounts
50% of your FICO score depends on the length of your credit history. However, if you take out a new loan to consolidate older debts, this new loan will be considered as a new source of credit and therefore, will lower the average age of your credit history as well as your FICO score.
Inquiries
Ten percent of your credit score is based on the number of new inquiries on your credit report. A high number of inquiries lowers your credit score because it makes lenders dubious about your loan repayment capacity. While applying for a new line of credit for consolidation, the company pulls your credit report once again and thereby affects your credit.
To conclude, the effect of debt consolidation services on your credit score is not permanent. If you pay the new consolidated loan consistently on time, it can help you to raise your credit score sooner than before.
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