Considering Debt Consolidation
Keeping track of multiple payment deadlines and numerous debts while receiving high-interest fees can cause some Americans to consider debt consolidation as an option for putting all debts on one loan payment---ideally at a lower interest rate than their current credit card rate. There are two types of debt consolidation loans: ones that utilize a home owner's equity in their current residence or a personal loan, which is offered strictly to the person taking out the loan at a varying percentage rate.
For those who are fully prepared to pay off this loan while not ringing up further charges on one's credit cards, debt consolidation offers Americans the opportunity to make one monthly payment, often at a lower price than paying each card individually. However, a debt consolidation loan can make an immediate impact on a person's credit rating, the impact of which should be considered before taking out the loan.
Closing Credit Cards
There are several factors that may affect how much your credit score is affected through a debt consolidation loan. The first is if you are required to close out credit cards as a result of paying off the loan. A portion of your credit score is determined based on your credit history. The longer you have a credit card and pay off this card on time, the higher your credit score will be. Closing credit cards, particularly your longest-running credit cards, can cause your credit score to lower.
In addition to reducing your credit history, closing out your credit cards also can lower your overall available credit. This number is your total outstanding debt over your overall credit card limits. For example, a person with $15,000 debt and $20,000 total credit limits has only 25 percent available credit. In order to achieve the best rankings, a person should aim to have less than 70 percent or more available credit.
Benefits v. Risks
Taking out a new loan can automatically affect a person's credit score. However, a person will experience a credit boost by not having as many outstanding debts. Credit agencies tend to look at the overall picture when it comes to debt consolidation loans, therefore other factors---such as paying your bills on time, length of time you have had credit cards open and ratio of debt to available credit---also are considered in addition to the consolidation loan. Providing that a person regularly makes payments on time on a loan for a period of one to two years, the debt consolidation loan may actually help a person's credit score.
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