When your debt is piling up and you expect your credit score to sink, a debt consolidation loan may be a solution for some people. This type of loan is designed to combine your debts into one debt, so you can make affordable monthly payments. Besides making your debt payments more manageable by having only one loan payment, the interest rate on the debt consolidation loan typically is lower than than the interest rates for the various debts that are consolidated. The long-term goals are to keep your accounts current, lower your monthly payments and prevent your credit score from falling. That's not always the result in the short term, however.
How the Loan Is Viewed
When you use a debt consolidation loan to pay off other credit accounts, a new creditor is listed on your credit report, which may have a slight temporary negative impact on your credit score. However, this will not increase the total amount of debt on your report, which is a more significant factor. According to Lending Tree, your credit score should improve in the long run if you keep up to date on your new payments in a consolidation loan.
When a Loan Hurts Your Score
Your debt consolidation loan can hurt your credit score if you use a company that also negotiates with your creditors to reduce the amount you owe on your outstanding credit accounts. While this saves you money, it will be listed on your credit history as a failure to pay off your full balance. If your account debts are not paid while the amount owed is being negotiated, this also hurts your credit score.
Using a Home as Collateral
The Federal Trade Commission cautions that while you may gain control of your debt with a debt consolidation loan, your home is often used as collateral with such a loan. If you miss payments on the loan, you could be in danger of losing your home. These loans may have some tax advantages that allow you to write off interest, but you may have to pay points on the loan that could negate that benefit.
Avoid Scams
Many businesses offer to help you solve your debt problems by negotiating with creditors or providing a consolidation loan. You should research the company before reaching any agreement to make sure it is legitimate and trustworthy and has your interests in mind, because its fees may be high and you will be providing personal information. Contact your local consumer protection agency or call the Better Business Bureau in the state in which the business is located to obtain information on the company.
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