Credit card debt is a serious problem. The average cardholder in the United States has a balance of $ 5,234. According to Federal Reserve, the average interest rate on credit cards is over 15.00%, which can cause your debt to escalate rapidly.
A debt consolidation loan can help get you back on track and save money over time. But do debt consolidation loans hurt your credit score? Here’s what you need to know.
What is a debt consolidation loan?
Credit cards often have high interest rates. If you only make the minimum payment owed each month, it can take years to pay off your debt. Worse yet, you will be paying a lot more than what you initially charged in interest charges.
If you have high interest rate debt, it may seem impossible to move forward. Much of your payment goes towards interest charges as the principal hardly budges. Getting discouraged is easy.
This is where debt consolidation loans can help. A debt consolidation loan is a personal loan that you take out to cover the cost of your current credit card balances and other forms of debt. It usually has lower interest rates than credit cards, and you have a fixed monthly payment and a repayment term.
According to Thomas Nitzsche, a credit educator with International money managementThere are several advantages to using a debt consolidation loan, including a lower interest rate, easy payment, and the ability to pay off your debt faster. With a lower rate, more of your payment goes towards principal instead of interest.
Are Debt Consolidation Loans Hurting Your Credit Score?
While debt consolidation loans can be helpful, make sure you understand how getting one can affect your credit score. You will likely see a decrease on your first request, but then you should expect to see your score improve.
âAs with any other loan, there will be an impact on the credit when you apply because of the difficult credit investigation,â Nitzsche said. âOnce transferred, freeing up credit limits on multiple accounts and making regular monthly payments on time on the consolidation loan (and any other outstanding debt) should help consumers improve their credit over the life of their repayment. “
One factor that the credit bureaus look at to determine your credit score is your debt-to-income ratio (DTI), or the portion of your income spent on debt repayment each month. With just one loan and one monthly payment on a consolidation loan rather than multiple credit cards and monthly bills, your DTI ratio will likely improve. Plus, you can pay off debt faster, which further improves your score.
But keep in mind that it’s essential to make all of your payments on time.
âAs with any other line of credit, if you don’t make payments every month, it will negatively impact credit,â Nitzsche said.
What to consider before taking out a consolidation loan
Debt consolidation loans can be a useful tool in paying off your debt. But they’re not a foolproof approach for everyone.
According to Nitzsche, one of the biggest problems he sees with clients who take out consolidation loans is that they don’t change their spending habits. Over time, they rebuild a credit card balance and have to pay off both the credit cards and the consolidation loan.
âOften this is accompanied by a reduced credit score, which makes them impossible to consolidate again,â Nitzsche said.
If you decide to take out a debt consolidation loan, be sure to take the following steps:
- Create and stick to a budget: A debt consolidation loan only works if you tackle the root cause of the problem that got you into debt in the first place. Create a budget and stick to it to avoid overspending and getting into debt again.
- Stay away from credit cards: While you are paying off the consolidation loan, try not to use your credit cards. Focus on paying cash to avoid juggling loan payments and credit card bills.
- Find ways to make additional payments: Try to pay off the loan as quickly as possible to save more money. By reducing your expenses and increasing your income with a side business, you can get rid of your debts sooner than expected.
Taking charge of your debt
Now that you know if debt consolidation loans are hurting your credit score, you can make a plan to tackle your debt. If you’re ready to change your spending habits and embark on a repayment strategy, getting a debt consolidation loan can be a smart move.
If you are ready to apply, here are some of the best debt consolidation lenders.
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