Depending on how it’s done, debt consolidation could improve your credit score by lowering the amount of outstanding debt you have. However, you must commit to following a repayment plan and avoid missing loan payments.
Missed payments can significantly damage your credit scores and lead to additional fees. If you think you might struggle to make payments, consider seeking financial counseling before applying for a debt consolidation loan.
1. Do Your Research
Before you apply for a debt consolidation loan, you should make sure that it will help you achieve your financial goals. This means doing research about the types of loans available, such as personal, home equity and credit card balance transfer loans, as well as their rates and terms. You can also find a variety of lenders and prequalify with them by providing basic information about yourself.
The goal of debt consolidation is to replace multiple payments with a single payment that may have a lower interest rate or longer repayment term. If you are struggling to keep up with your current debt payments, a debt consolidation loan may be the right choice for you. But it will not be a solution to your overall money management problems, so it’s important to get to the root of why you were spending beyond your means in the first place and make changes going forward. That might mean working with a credit counselor to build a budget and develop healthy financial habits.
2. Make a Budget
Using debt consolidation to pay off multiple loans and credit cards can help simplify your budget. With just one monthly payment, you’ll no longer have to worry about keeping track of multiple due dates or getting caught off guard by unexpected expenses. It’s important to note, however, that you should be able to comfortably afford the loan payments or else risk falling behind on them—missing debt repayments can negatively affect your credit score and may result in additional fees and late payment penalties.
To avoid the risk of falling behind on your debt consolidation payments, consider setting up automatic payments or otherwise utilizing autopay features to make sure you can stay on top of your debt repayment plan. It’s also a good idea to review your budget and consider how you could adjust your spending habits for a while in order to free up cash flow that can be used to make debt repayments. If you find yourself struggling to meet your debt payments, you should get free counseling from a nonprofit credit counselor or explore other options like a balance transfer credit card with a 0% APR promo period.
3. Set Goals
Debt consolidation makes it easier to manage multiple debts by focusing on one payment. It also helps you save money by lowering your interest rate, which can make it quicker and less costly to pay off your debt.
When choosing a debt consolidation strategy, consider how it will affect your credit score. Generally, getting a debt consolidation loan will boost your credit scores because it lowers your credit utilization ratio and shows you’re responsible with making on-time payments.
However, if you have poor spending habits, you should focus on changing those first before taking out another form of debt like a new credit card. Otherwise, you might find yourself in trouble again before long and will need to consolidate your debt once more. Make sure you set a clear plan to get your finances in order and use an autopay system to avoid missing any payments that could hurt your credit score or lead to additional fees.
4. Pay Off Your Debts
If you have a solid budget and want to lower your monthly debt payments, debt consolidation may help. However, it’s important to know that this method of debt repayment won’t help you get out of debt faster unless you also cut spending and/or increase income.
In addition, it’s worth mentioning that debt consolidation often comes with upfront fees, and the total cost of your loan will depend on your credit score, debt-to-income ratio and loan amount. Plus, some forms of debt consolidation require collateral — like a home equity loan or 401(k) loan — and may expose you to risk if you can’t repay the debt.
If you don’t think a debt consolidation loan is right for you, consider other options. Alternatives to a debt consolidation loan include debt management plans and debt settlement, which involves negotiating with creditors to settle your debts for less than you owe. Also, avoid taking on new debt if possible.