Does debt consolidation hurt your credit?
Many Canadians worry about whether debt consolidation will have an impact on their finances, but the truth of the matter is that debt consolidation does not hurt your credit in the long run. As long as you’re taking the right steps and consolidating through the right avenues. It’s a strategic financial move that can save you hundreds, even thousands of dollars in interest over the course of your repayments.
Let’s explore how debt consolidation works and answer the big question — does debt consolidation hurt your credit?
How does debt consolidation work?
To understand the effects of debt consolidation on your credit, it’s important to first understand how debt consolidation works. The concept of debt consolidation works two achieve two things:
- To bring multiple lines of debt into one place so that it’s easier to manage
- To reduce the overall interest rates you’re paying on owed amounts into one, low, manageable rate
To do this, you start by taking out a loan with the lender you’re using to consolidate your debt. You’ll then use the funds you’ve borrowed to completely pay off other lines of debt—lines of credit, credit cards, student loans and auto loans are all examples of this.
This effectively moves your loan from the various lines to your debt consolidation lender, with whom you’ve hopefully secured an affordable and manageable rate. Home equity loans are the most common avenues for debt consolidation due to the large amount of equity value most homeowners can secure their loan against.
Do consolidation loans hurt your credit?
The nature of debt consolidation and loan repayments themselves has led to a sort of stigma against anything that affects an individual’s credit score. This leads many individuals who already have less than ideal credit scores from considering debt consolidation as an option, even though they’re one of the groups most likely to benefit from it.
It should be emphasized that when provided by the right lenders and managed carefully, consolidation loans don’t hurt your credit. They’re designed to help you make your debt more manageable and actually improve your credit slowly over time.
How does debt consolidation affect your credit?
Let’s make it clear. Does consolidation debt hurt your credit? Only initially. One of the caveats of debt consolidation is that for it to work, it requires you to take out one more loan or credit line, the one that you’re using to bring all your debts into one place.
The results of doing so can affect your credit, so let’s go over them to understand their impact.
Taking out your debt consolidation loan puts in a hard inquiry
A hard inquiry is the result of the credit check that your lender performs when you apply, and it indicates you’re taking out a loan. Hard inquiries do reduce your credit score slightly, but they’re a natural part of the debt consolidation process, and their effects only last about a year, after which your score will return to normal.
Closing credit accounts can drop your score
Most people would assume that closing a credit account is a good thing, considering you’ve finished up your business with the lender without any owed amounts remaining. However, the number of open credit accounts you hold make up a big part of your credit score, and the older they are, the greater their impact. If you choose to close any accounts after paying them off, you’ll see a drop in your score.
You can easily avoid this by keeping those credit lines open. However, you’ll also have to make sure to resist the temptation to access those credit lines again. If you don’t feel comfortable leaving these credit lines open, it’s better to close them—it can be healthier in the long run to do so.
High credit usage can cause lower score
If you actively get close to or max out your credit limits, you might have a high credit utilization ratio, which has a negative impact on your credit score. Specifically, when usage is at 10% or higher, you’ll see a drop. Note that this usage value takes into account your total credit availability across all your accounts, so it’s much harder to actively use more than 10% of your credit values than you might think.
That being said, even if you do have high credit utilization, paying off your owed amounts also improves your credit score, bringing it back to normal. This makes it a normal part of the process and doesn’t have any lasting effects on your credit in the grand scheme of things.
When should you consolidate your debt?
From what we’ve covered, it should be clear to anyone who asks: Does consolidating debt hurt credit? No, if you’ve understood the process and acted accordingly, you won’t hurt your credit in any lasting way through debt consolidation.
But remember that consolidating debt is not necessarily a solution for everyone. The best time to consolidate your debt is when you’re struggling to handle high interest rates and charges on several smaller, separate loans. Using debt consolidation is a solid strategy to get back on track with managing your debt and paying it off. It can also be a fantastic option for Canadians with several credit accounts that are difficult to keep track of and pay on time.
However, debt consolidation won’t help you if you don’t have the ability to handle your repayment amounts. A solid source of income and careful money management is still necessary for you to properly pay off loans.
If you’re wondering about the best options for debt consolidation, look no further than Alpine Credits. We’ve helped Canadians find affordable loan options to consolidate their debt through home equity financing for over 50 years. Don’t hesitate — call us today to learn more about how our specialists can help you find a great rate on a debt consolidation plan that works for you.