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Does Loan Consolidation Affect Your Credit Score? Here is the Truth

Mar 23, 2008
Does consolidating debt via a debt consolidation loan affect your credit score? Definitely. But does it affect it negatively? That's a more difficult question. Credit score calculations are very complex entities involving many factors, so it's not a cut-and-dry issue as to how they are impacted by debt consolidation loans. Certain aspects of consolidating your debt will have a positive effect and other aspects will have a negative effect. What you are probably going to find is that your credit takes a hit in the short-term, but ends up improved over the long-term, assuming all debt payments are made in a timely fashion.

At one time, creditors who dealt with loan consolidation companies would report a status of "third-party assistance" to the credit bureaus, which had a negative effect on your credit rating. Fortunately, creditors are more enlightened these days and debt consolidation is very common. Just the act of consolidating your debt does not in itself do any damage to your credit rating. What does do some damage is the way the consolidation process works.

When a consolidation company begins the process of negotiation with your creditors, your debt repayment may be suspended. This results in the possibility of late payments being reported to the credit bureaus. So for a while, possibly up to four to six months, you may have late payments recorded on your credit report, which will drive your credit score down. Even after your original creditors begin receiving payments from your credit consolidator, some creditors require three months of payments before they will make a positive report to the credit bureaus. Once everything is settled, the credit card companies will no longer report you as a delinquent account. However, it is important that your debt consolidator dictate this requirement to your creditors. You may want to verify this with the debt consolidator.

This negative effect is temporary, assuming you make timely payments on your consolidation loan. Long-term, debt consolidation is more likely to affect you in a positive way. For instance, having lots of credit cards that are maxed out brings your credit score down because your outstanding balance is such a high percentage of your total available credit. When that debt is moved to a consolidation loan, then your outstanding credit card debt becomes zero. As a result, you will no longer be penalized for having such a large amount of credit card debt relative to your credit limits. In addition, if you have other kinds of debts that are included in the consolidation loan, such as an automobile loan, then you will receive a credit score boost from paying off those loans.

One thing that you should NOT do after consolidating credit card debt is to close your credit card accounts. Intuitively, you might think that decreasing your total debt generating capacity is a good thing (and it probably is strictly from a personal perspective), but from a creditor's perspective it is a negative because it reduces your total available credit, thus increasing the percentage of your credit that you are utilizing. You are better off to keep your credit card accounts open...just don't start using your cards again! At least not until your consolidation loan is paid off.

In summary, with a debt consolidation loan, you will likely experience a short-term ding in your credit rating related to the time required to get all of your debt consolidated. However, if you make your new loan payments on-time every month, the long-term affect will be a positive credit boost.
About the Author
ClearOne Debt Relief is a full-service debt management company providing debt settlement services such as credit card debt relief to hundreds of thousands of customers. We help people cut their debt in half, lower their monthly payment, and get out of debt in as little as 24 months.
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