Will consolidating debt hurt my credit score?
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UPDATED: Jan 12, 2012
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Unfortunately consolidating debt does hurt a borrower’s credit score. But credit scores can always be corrected over time, and consolidating debt may be necessary to ensure a healthy financial future. If borrowers are struggling under the weight of their current debt and monthly bills, they shouldn’t hesitate to seek help through debt consolidation simply due to credit score concerns.
When borrowers seek to consolidate their debt, they are essentially coming to an agreement with current lenders that will allow borrowers to merge all of their existing debt into a single, lower monthly payment. That payment is given to a consolidation company who then manages the money and disburses it to the individual creditors on behalf of the borrowers.
The single payment made to a consolidation company usually comes with a reduced interest rate, reducing borrowers’ likelihood of defaulting.
For example, imagine a borrower who has one personal loan of $10,000 for five years at a 10 percent interest rate (loan A). That same borrower also has a $5,000 for five years at a 12 percent interest rate (loan B).
On loan A, the borrower can expect a monthly payment of around $212, and over the course of the loan he will pay out nearly $2,750 in interest.
On loan B, the borrower can expect a monthly payment of around $111, and over the course of the loan he will pay out nearly $1,675 in interest.
This borrower is paying $323 a month just to satisfy his personal loan bills. This may be on top of a mortgage payment, or rent, or an auto loan. Regardless of the situation, imagine the borrower is unable to keep current with his personal loan payment. It would be in everybody’s best interest—both lender’s and borrower’s—if the borrower opts to consolidate his debt.
A debt consolidation company may take a look at both loan A and loan B and offer to consolidate them together at a 10 percent interest rate over seven years. That would reduce the borrower’s payment to just under $250 a month. While the total interest would increase, the borrower would be able to keep current on their payments, and the lenders would receive their money—albeit over a longer period of time.
Through personal loan debt consolidation, the borrower will be able to save his credit score from a much more severe blow—one caused by either constant default or bankruptcy—and pay back his debt at a manageable rate.