Ever feel like you are drowning in bills and the only people around you are debt collectors? Instead of ignoring your financial crisis, you need to get help.
One solution that’s tossed around a lot is debt consolidation. You’ve probably heard of it, but you may not realize exactly what is at stake when you sign up for this program.
A debt consolidation loan opens up a new line of credit, which you can then use to pay off all your outstanding debt. There are several advantages:
- Interest rate is lower
- Only one bill a month
- Easier budgeting
- Stops interest rates and fees from accruing on the old debt
You can consolidate debt using a credit card balance transfer, a personal loan or a home equity loan.
Keep in mind that a home equity loan or a second mortgage requires you to put your home up for collateral. That can be a risky bet for people who struggle to pay their bills.
If you can’t make the payments for the life of the loan, you could lose your home.
No matter what kind of debt consolidation loan you get, it can affect your credit score.
Anytime you apply for a new line of credit, the lender makes a hard inquiry on your credit. This will lower your credit score by a few points in the short term.
Transferring all your debt to a new credit card could also lower your credit score if it brings you near your maximum balance on that card. You maybe able to avoid this if you qualify for a high credit line.
Once approved for a loan or a new card, you will have a greater total amount of credit available.
This could actually increase your score because it changes your debt to credit ratio or the percentage of total available credit you are currently using.
If you consolidate your debt and then close out your old credit cards, it lowers the total amount of credit that is available to you.
That will change your debt to credit ratio and your score will drop, especially if you close out your oldest credit cards.
So your best course of action is to open up a new line of credit and keep your old credit cards open – but never use them! This can be especially difficult for anyone already deep in debt.
Unless you get counseling services to break your pattern of spending, bad money habits can sink your attempts to get back on track.
Something else to consider:
If you are working through a company to set up a debt consolidation loan, they may work with your creditors to lower your balance.
While it sounds good, this could also lower your score because the creditor may report it as a bad debt or charge off.
No matter what route you take, paying off your debt on time each month will ultimately help your credit score and help you get better interest rates down the road.
The key is not to get caught up in the trap of taking on new debt.
Photo source: debtreliefnetwork.com.