How Debt Consolidation Affects Your Credit

Debt consolidation combines several individual debts into one single monthly payment at a set interest rate. It is essentially a type of debt management plan for dealing with high-interest repayments, like credit card debt. It can be an effective way to restructure debt and regain control over your finances.

As multiple debts and repayments can be a source of stress, debt consolidation can have significant psychological benefits for debtors. It’s also possible to arrange a debt consolidation deal that results in lower average interest rates or lower overall monthly payments, helping you manage your debt more responsibly.

Reducing interest rates, total debt, or monthly repayments enables you to pay off debt faster, putting you in a better financial position.

Financial institutions such as banks, credit unions, and other online lenders offer debt consolidation loans. Once you consolidate debt, you owe all future payments to the new lender. If you’re considering applying for a debt consolidation loan, T&I Credit Union offers a competitive APR on 24, 36, and 48-month personal loans for consolidating debt.

Why You Might Consolidate Debt

One of the most popular reasons for consolidating debt is reducing interest rates and lowering overall monthly payments. For example, if you have credit cards with a 20% or more interest rate, consolidating your debt into a loan or new credit card can reduce your monthly interest payments, saving you money.

Consolidating debt is also an effective way to organize your bills and know exactly what you are paying in interest. Debt consolidation simplifies the payment structure, giving you fewer accounts to manage and reducing the likelihood of accidentally missing payments.

How to Consolidate Debt

There are several ways to consolidate debt:

Personal Loan

If you can secure a personal loan from a financial institution that enables you to pay off high-interest bills at a lower rate, it may be a worthwhile consolidation option. This gives you more control over your regular payments and allows you to pay off your bills faster and more conveniently.

Balance Transfer Credit Cards

Some credit card companies offer balance transfer cards to their customers. These cards include introductory periods where little or no interest is charged on balances transferred to the credit account within a specific period. This allows you to get a head start on repayments and make progress with debts for a limited time.

Just ensure you can pay off the credit card within the time period, or you could be stuck with a hefty interest rate once the introductory period expires.

Retirement Account Loans

If you have a retirement account, it may be possible to use it for financing a consolidation loan. However, it’s important to pay close attention to the specific rules of your retirement plan to avoid paying penalties or being charged extra fees and taxes.

Home Equity Loan or Line of Credit

Home equity loans allow you to take out a line of credit, using your home as collateral to consolidate the debt, provided you’ve built an ownership stake in the home. This type of consolidation plan often offers lower interest rates than other consolidation options, but it comes with the risk that you may lose your home if you fail to pay it back.

There are several pros and cons to factor into your decision to consolidate debts. Before you begin the process, it’s very important to consider how debt consolidation affects your credit.

How Debt Consolidation Affects Your Credit Score

Debt consolidation isn’t quite as simple as combining regular repayments into single monthly bills. The objective of debt consolidation is to reduce debt into a single manageable payment, not increase credit score. Here are some ways debt consolidation can impact your credit score:

Improve Payment History

Payment history accounts for approximately 35% of your credit score. If current debts prove too challenging to pay on time, your credit score will take a hit. This is why it’s critical to structure a debt consolidation plan that works for you. If you cannot make monthly payments on time, debt consolidation is likely to reduce your credit score even more.

Although it may take some time, a well-arranged debt consolidation plan enables you to make timely payments, improve your payment history, and increase your credit score over time.

Initial Hard Inquiry

Each time you apply for a debt consolidation loan with a financial institution, they make an inquiry on your credit standing by pulling your credit report. Hard inquiries typically reduce your credit score by a few points. If you are shopping around between financial institutions to compare prices, multiple checks can result in a significant hit to your credit score.

It’s important to time your applications within a short window to ensure all inquiries result in a single credit score reduction. Contact one of the major credit bureaus to determine your available window. This period may be anywhere between 14 and 45 days.

Consider approaching financial institutions with a soft inquiry that doesn’t harm your credit score to avoid unnecessary credit hits. Soft inquiries differ from hard inquiries because they aren’t associated with an official application for credit. This approach enables you to explore your options without suffering damaging consequences.

Lowers Credit Utilization Ratio

Your credit utilization is an important metric for lenders and is critical in calculating your credit score. It accounts for 30% of your FICO score.

A credit utilization ratio represents how much of your total available credit you are using. Although financial experts disagree on an ideal credit utilization ratio, keeping it at 30% or lower is recommended. However, if you’re struggling to manage your debts, there is a strong likelihood this number may be significantly higher for you.

The debt consolidation process can raise your credit utilization ratio because it involves transferring balances, opening credit accounts, and applying for new lines of credit. Increasing this ratio significantly can harm your credit score.

Debt Consolidation affects credit

Closing Accounts Can Lower Credit Score

When consolidating multiple debts into a single repayment with a new lender, you may be tempted to close your accounts with some of your old creditors to avoid more debt. While this may seem like a good idea, in theory, it can hurt your credit score because it reduces the average age of your credit accounts.

One of the most important metrics for calculating your credit score is the average age of the credit accounts you hold. The higher this number, the better your score. Any new credit account you open for consolidating debt lowers your score. As the average age of your accounts makes up 15% of your credit score, it’s important to exercise caution every time you consider opening or closing an account.

Once you complete the debt consolidation process, leaving your old credit accounts open with zero balances may be more beneficial. This helps keep your credit utilization number stable and ensures your credit score isn’t adversely impacted.

The Right Way to Consolidate Debt

If you are a Michigan resident, one of the smartest approaches for consolidating debt is to speak with an associate at T&I Credit Union. As a credit union, we are member-owned, so we always offer the most competitive rates possible for all our financial services, from mortgages to personal loans. If you’re having difficulty keeping up with bills and repayments or are struggling to manage debts, we are here to help.

Our debt consolidation services include competitive interest rates, special offers, and deals, accompanied by continued support.

If you’re interested in consolidating a car debt, student loan, credit card debts, and other repayments, partner with T&I Credit Union to regain control of your finances.

T&I Credit Union Personal Loan Debt Consolidation

We offer personal loans up to $10,000 for consolidating debt. These loans are available between two and four years. Two-year loans have a current starting APR of 5%, while three and four-year loans have starting APRs of 6% and 7%. These rates are dependent on a credit check and are subject to change.

T&I Credit Union Credit Card Debt Consolidation

Taking out a credit card with a lower interest rate and transferring your debt to this card can be a useful tactic. You’ll reduce your monthly payments and making timely payments can help you build your credit score.

How to Apply

With T&I Credit Union, you can apply for a personal loan to consolidate debt. Get the process started by applying online, and you can expect to hear back from us within one business day.

While you’re waiting for our response, get an estimate on your new monthly payment using our loan calculator. For a more accurate estimate, we can make a soft credit inquiry.

If you choose to go ahead with one of our consolidation plans, a hard credit inquiry is necessary. This will lower your credit score initially, but generally only up to a maximum of five points.

By becoming a member of T&I Credit Union, you qualify for free financial counseling as part of our additional member services. We offer professional guidance, webinars, and credit score analysis to help raise your credit score, lower interest payments, and eliminate debts.

Other helpful member services include online banking, eStatements, a mobile app, debit and ATM cards, and wire transfers.

For more information on debt consolidation and our services, explore our website, contact your local branch, or get in touch with T&I Credit Union today at (248) 588-6688.

About Jeff Jacobs