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Will debt consolidation hurt my credit?

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Debt consolidation helps you pay off unsecured debts, like credit cards, for less than what you owe, giving you a way out of overwhelming high-interest debt.

But debt consolidation comes with risks, including a lower credit score. Learn how debt consolidation works, how it affects your credit score, and what alternatives you should consider.

How does debt consolidation work?

Debt consolidation is the process of reducing the amount of debt you owe to less than it actually is, usually with the help of a third party such as a debt consolidation company.

Debt consolidation companies usually advise you to stop paying the debt and put the money into a separate escrow account. As you become more delinquent in your debt, your creditors are more likely to accept your settlement offer than risk you never paying at all. If the creditor accepts your settlement offer, the consolidation company will use the money in the escrow account to settle the debt.

How does debt consolidation affect credit?

Debt consolidation can negatively affect your credit in several ways.

  • Late Payments: When you stop paying your debt, your creditors will report this. Late payments It is reported to the credit bureaus after 30 days, and your payment history is a large part of your credit score, so late or missed payments will lower your score.

  • Total debt may increase: When interest accrues on a credit card, Credit Utilization Rate This ratio measures how much of your available credit you’re using and is an important factor in calculating your credit score. Typically, the more debt you have relative to your available credit, the worse your credit score will be.

  • Collection Activities: As your account becomes more delinquent, your debt may be turned over to in-house or third-party collection agencies. Collection Account The impact on your credit report could cause your credit score to drop further, but this may depend on how much your credit score has already been affected.

  • Settled accounts will appear on your credit report: A settled account indicates that you have not paid your debt in full and is considered a negative to future creditors. A settled account will remain on your credit report for seven years.

Can debt consolidation improve your credit?

Debt consolidation is likely a better choice than not dealing with your debt at all. From that perspective, it may be better for your credit than letting yourself get increasingly into debt with no plan to get out of it. However, these aren’t your only options. It’s wise to explore debt relief options other than debt consolidation.

Debt consolidation alternatives

Before hiring a debt consolidation company, consider other ways to resolve your debt.

Debt Management Plan

Debt management plans consolidate your credit card payments into one low-interest payment, making it easier to repay. These plans are offered by nonprofit credit counseling agencies and can help you pay off your debt over three to five years. Joining a debt management plan may initially lower your credit score, but your credit may improve once you complete the plan.

Debt consolidation loan

A debt consolidation loan is similar to a debt management plan and is a personal loan that combines multiple debts into one that is easier to pay off, preferably at a lower interest rate. Even if you have bad credit, you can apply for this type of loan at a local credit union or online lender.

To apply for a debt consolidation loan, Hard Credit PullIt will temporarily take a few points off your credit score. As long as you make your loan payments on time, a debt consolidation loan can help you improve your credit score.

bankruptcy

If your debt takes up more than 40% of your income and will take more than five years to repay, bankruptcy It may be an option for you. Filing Chapter 7 bankruptcy allows you to wipe out unsecured debts, but like debt consolidation, it has a significant effect on your credit score. However, your score may recover faster with bankruptcy than with debt consolidation. A credit counselor can help you decide if bankruptcy is right for you.

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