Debt consolidation involves combining all your credit balances into one loan. The idea here is to reduce the burden of having to pay for many debts independently. This way, you will have lower rates of interest. Also, you will have a comfortable ride in repayment. The counter idea is that when you adopt consolidation, you have to honor all payments.
This is because; missing open installment makes the consequences for the already higher stakes grow worse. You will find here some notes on ways one can consolidate a debt, how debt consolidation works, and its effects on your credit scores.
Reasons for debt consolidation
One of the standard practices in credit consolidations is that the borrower looks for the lender who offers affordable rates, which are lower than those of the debt you want to consolidate. Therefore, by doing so, you are transferring your debt that comes with its high-interest rates. They are refinanced and given new terms and conditions with a lower interest rating. This way, you get to save money, regardless of the additional costs on the transfer.
Furthermore, it is convenient. You can quickly pay off one loan than having to manage a variety of them. The chance of making a mistake generally reduces. Since an early repayment does well for your scores, since consolidation helps you to manage payment, it, therefore, helps in building your scores.
Additionally, you can opt for consolidation if you are looking to reduce the high loan rates on the balances you are currently shouldering with low rates of interest on the new loan. This makes it much easier for you to save the extra cash on something else after repayment.
Ways of debt consolidation
Consolidation works when multiple loan balances are merged into one typical debt. However, this does not work best on all types of loans. Here is a discussion on ways to better consolidate your credits.
Personal loans: Credit card balances generally have higher rates compared to some personal; loans. If you are eligible for one, take it out on your credit cards to help you clear your debt faster.
Balance transfer credit cards: There is a particular category of credit cards called balance transfer cards. With these cards, if you transfer your card balances within a set period, you qualify for no or low rates of interest in the introduction. This window gives you a chance to save on the interest rates.
Home equity line of credit (HELOC): This is a second or subsequent mortgage on your home. It is, therefore, a loan you take against your house after your stake or equity in the house is established to be substantial enough to warrant the loan. These kinds of loans offer meager credit rates. Compare this to your credit cards; you will be looking at an exciting bargain when you apply for consolidation.
Retirement benefit loans: you are open to taking your retirement funds from the account for loan consolidation.
However, you face penalties and taxes when you are late repaying them. Usually, these funds are secured by some rules and regulations that are ought to be followed by every signatory to the contract.
The effect debt consolidation has on your credit ratings.
Debt consolidation is all positive. However, it initially leads to a drop in your ratings momentarily before they pick up again. Here is why:
Before your loan application is accepted, it is first analyzed. The process involves pulling your credit rating reports. Hard pulls on your credit reports always lead to a drop in your scores for at least a few points. This is called hard inquiries, and the loan underwriters use it as a basic measure in evaluating one’s creditworthiness. So, even before you consolidate. Your scores are already shedding off.
Insufficient credit age
Credit age is the total amount of time you have had a credit account. A positive rating on an older account tends to exude confidence hence show higher ratings. Additional newer considerations affect the credit age negatively. This will, therefore, cause your scores to plummet.
New debt account
As indicated above, a new account affects your credit rating severely. This reduction is, however, low as lenders review your activities in the new account. A new credit account will always pose a heightened risk. Therefore, to get your scores to levels, they were initially; do not misuse this new account.
The commonality of consolidation loans suggests that they play more decisive roles on your credit that they affect it negatively. Here are a few ways:
It lowers the credit utilization ratio.
A lower credit utilization ratio has two effects. Firstly, it moves to counter some of the impact caused by opening another credit account. Secondly, it helps to increase your available credit to spend. With credit cards, you receive a card with a maximum possible amount you can use. Your utilization ratio is measured against the amount you have left to clear your usage allowance. It is deemed to be high if the usage surpasses three-quarters of the maximum allowable funds. However, opening another account increases this amount, hence lowering the utilization ratio. The net effect is that your credit scores increase if the rate is low.
Eases your payment schedule
Debt consolidation eases how you pay your loans. This, therefore, helps build your scores. Here, your credit ratings depend on the timely payment of the installments. Nevertheless, since the rates are lowered, you will have an easy time posting the payments.
The bottom line
Debt consolidation helps you to avert a debt crisis with your credits. It is a positive tool to use to keep yourself standing after a series of blows that the credit card debts throw at you. However, before getting to this point, you should exercise the safe rule with credit cards. The rule is to keep zero balances on your cards. Your credit will soar if you use your card regularly and post all the payments at the end of the month. This will avert higher rates of interest as it will stop you from moving to consolidate.