There are several reasons why we borrow money – different purposes, different sources, different lenders, ending up to multiple debts and loans we need to pay for either monthly, quarterly or annually, depending on the terms and conditions the loans impose, not to mention varied interest rates on each debt. Most of the times, maintaining a number of debts makes it harder to monitor, costs more than it should have due to penalties and more stressful to upkeep. As a remedy, lenders offer debt or loan consolidation. Consolidation of debts or loans means taking out a new loan to pay off smaller debts such as credit card debt, personal loans, and student loans. In effect, proceeds from the single larger debt settle multiple smaller debts, and monthly payment will only be made to a single loan, usually with more favorable payment terms, either lower interest rate, lower monthly payment or longer terms of payment. Generally, debt consolidation involves unsecured debts or those that have no collaterals involved.
During application of debts and loans, lenders would make credit reviews and assessments through Credit Score. This number indicates the likelihood of an individual to pay its accounts. Risks of incapability of paying debts, untimely and delayed payments and even non-payments may be revealed through credit scores. Records and history of debts and loans, the payments made, the timing of payments and even penalties and surcharges imposed on your loans are interpreted and reflected in your score. But, how does debt consolidation affect credit score?
Credit scores are directly affected by deciding to consolidate debts. If you are a loan debtor maintaining a good level of credit score, this article will help you monitor and assess the positive effect of debt refinancing not only to your current loans but also to all your future loans which you may apply for.
Loan Consolidation Advantages
1. Easier to budget
Instead of juggling different debts with minimum payment requirements with different due dates, debt consolidation offers fixed rate and term and schedule of payments resulting to easier budgeting process since you only be reminding yourself of a single payment, with a specific interest rate on a specific date. This will help you minimize delayed or missed payments of debt and thus increasing the level of your credit score.
2. Stress reduction
Debt is one the most common and popular cause of stress. Monitoring multiple debts with different interest rates, due dates and mode of payments may cause a lot of stresses. Taking out a debt consolidation may significantly reduce your stress since it will allow you to focus on single payment monthly (if such were the case). Other energies may be directed towards other productive activities such as raising fund for future payments of the larger debt.
3. Stop collection calls
This may be attributable to stress reduction since several calls interrupting you during office hours or even in your rest days and hours may be irritating and annoying, especially if a collection agency was engaged to do the job. Thru debt consolidation, these calls following-up your payments will be minimized, if not fully stopped.
4. Credit life diversity
Applying for a new loan thru debt consolidation will create a mixture of revolving credit (credit card debt, short-term loans) and installment account (personal loans). Proceeds from installment loans will be used for revolving credit and since installment accounts impose longer terms of payment, the debtor may have more time to raise funds to settle the long-term loan, without incurring penalties and surcharges for delayed payments due to unavailability of funds which are very common to short-term credits.
5. Paid delinquent debts
It is inevitable for short-term credits to impose penalties, in addition to interests, whenever the debtor fails to pay on time. Most often than not, these penalties pile up to the debtor’s accounts, especially if monthly payments are only focused and budgeted for what is due for the month, principal plus interest. Thru debt consolidation, the debtor will be able to settle additional penalties which may have been imposed to his credit accounts. Also, assuming all debts are consolidated, delinquent or bad debts which may not have been settled for a long time, will be paid in full. Thus, putting an end to the possibilities of surcharges due to delinquency and decreasing your total debts.
6. Decreased credit utilisation ratio
Debt consolidation will help you settle not only delinquent and overdue debts with surcharges and penalties but also some debts which are not yet due. This will prohibit incurrence of additional penalties and finance charges to those accounts. As the balances of your debts decrease, a parallel effect may be expected in your credit utilization ratio.
Credit utilization ratio is the rate of the amount of credit you used or applied for and maintained over the total amount of credit available to you, or the credit limit. The formula is as follows:
Credit utilization ratio = Total actual debts / Total applicable credits (Credit limit)
In effect:
- High Utilization Ratio = Low Credit Score
- Low Utilization Ratio = High Credit Score
7. Boost credit score
Credit score, otherwise credit rating, as mentioned, is the number which serves as the basis to review and assess the risk of lending to an individual as their debtor. The higher the credit score, the easier for an individual applying for loans or credits to secure such. Also, better credit terms as to interest rates, credit terms, or even mode of payments, may be awarded to loan applicants with higher scores.
Takeaway
Late and missed payments with additional penalties and surcharges will increase your total credits (even your delinquent accounts) which may result to increased utilization rate, thus reducing your credit score. Through loan consolidation, your credit scores may boost by ensuring prompt and timely payments of debts since there would only be a single payment of debt on a particular date with fixed and specific interest rates, the likelihood of missed payments will be minimized since the schedule and amount of payment will be easier to monitor, track and pay.
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