Most Americans are looking for a solution to absolve their debts and improve their financial health. In eliminating debt everyone has heard of the many alternatives in debt management. In joining these programs the primary concern most consumers have is how their credit score will be affected long-term. Debt management, debt consolidation, does affect your credit but it depends on what type of plan you go with. Knowing and understanding how each of these affects your credit can help you make an educated decision that coincides with your financial goals.
Consolidation Loan: Everyone wants to pay back less in interest and consolidation loans have provided a debt management plan for those who qualify. A consolidation loan provides a line of credit to the consumer in which all their other unsecured debts can be transferred and combined for the convenience of one monthly payment at one interest rate. The amount of debt you owe is not decreased but consolidated into one account to avoid paying various rates to various lenders. This doesn’t necessarily help improve your credit score as you are not decreasing the overall debt, but have taken on one great debt to zero out a few smaller ones. If you have good credit and are having a hard time keeping up with multiple statements and payments a consolidation loan could be beneficial. Run the numbers, see what the rate offered is for the loan and then see when that rate expires and what the default penalties are.
Debt Settlement: A settlement program is a debt management plan that also manages and consolidates credit debt into one monthly payment. The settlement agency makes settlement offers to the creditors on your behalf in an effort to have the outstanding balance reduced by 60-70 percent. In order to settle with a creditor for a reduced payback amount the debt must first be charged off. A creditor will charge off a debt after it has been delinquent for an extended period of time, usually 5-6 consecutive months. A charged off debt is a serious negative mark on your credit report and remains on your credit for seven years, regardless if the debt is paid back or not. Imagine you loan someone $5k and after a couple of years they only wind up paying you back $2500. Would you be willing to lend that person money again? Probably not and that is how most banks look at charged off debts. Someone concerned about their credit score or looking at purchasing a home or an auto loan in the next ten years may want to reconsider this option. For those who have debts in the rears for more than 6 months, the accounts are already charged off, and are looking at bankruptcy may benefit from a settlement plan versus bankruptcy or credit consolidation.
Debt Consolidation: Like other options, your unsecured debts are consolidated into one monthly payment and the debts are managed by a third party. A consolidation program negotiates rates and interest with the creditors, not the outstanding balance. This allows consumers to pay back the amount they owe but at reduced rates to allow more of each payment to go to the principle balance over creditor fees and interest. The interest rates are reduced to fixed rates, usually between 0-10 percent. The reduced fees allow the balances to drop faster, lowering the consumers overall debt amount at an accelerated rate. 30 percent of your credit report is determined by the total amount owed. Another 35 percent of your credit score is affected by consecutive payments. Therefore, a consolidation plan can actually improve your credit score over time with consecutive monthly payments and faster balance reductions.
Speak to a certified credit counselor for a free budget counseling session and credit consolidation consultation. An initial counseling session with a non-profit will help assess what your situation is, your long term financial goals and what option best suits you based on your specific situation. Call a certified credit counselor today 800-905-1563 or visit our website freedomdm.org for a free counseling session.