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For individuals in financial difficulty, debt consolidation may seem like a good answer to debt and problems. There are different types of credit consolidation, though. Choose carefully, or your credit score and credit history could take a big hit. Let’s look at the different types of credit card consolidation.
Credit card consolidation with another loan: When you transfer all your credit card debt into one lower interest loan — whether that is a home equity loan, personal loan, or even just another credit card with a lower interest rate, this barely affects your credit score. This is the most effective way to consolidate your credit card debt without hurting your credit history. If you are not behind in payments, or are only 60 days or less behind, consider this type of debt consolidation. Your credit score may take a small hit when the loan or credit card company pulls your credit file to approve you for the loan, and will take another hit when you open a new account. (Newly opened accounts can lower your credit score by about 5 points.) New accounts and credit inquiries only affect your credit score for about six months. And your FICO credit score will soon begin to increase when you begin paying off your debt and your debt-to-available credit ratio rises.
Credit Counseling: When you seek credit counseling from a reputable company, the company will work on your half to negotiate manageable payments for your credit card debt. The credit counseling agency may negotiate lower interest rates for your debt, but you’ll still pay the full amount you owe. This will not affect your credit score, but it will go on your credit file that you’ve used credit counseling. Some lenders look on this poorly — it’s sending the message that you can’t manage your credit on your own, and that you got yourself into financial trouble with debt.
Debt settlement: Another type of credit card consolidation, debt settlement, can have negative effects on your credit score. In fact, if you’re already behind on your credit card payments, debt settlement could look as bad as a bankruptcy in some cases. In a debt settlement or debt renegotiation, the debt settlement company calls your creditors and works out a payment plan and settlement for you. You may be able to pay just 40 or 50% of your original debt, at a lower interest rate. When you use a debt settlement company, the debt settlement company actually waits until your accounts are in default 90 days before they can negotiate with your creditors. The first few monthly payments you make may not go to your creditors, but to the debt settlement company. In the meantime, your credit score will continue to drop since you’re not making payments. When your debts are finally paid, your credit file will show the accounts as “Paid – Settled,” not “Paid in Full.” This also affects your credit score.
If you want to get out of debt in order to buy a house, new car or other purchase that requires a loan, debt settlement is not the best answer. However, debt settlement is not as bad as a bankruptcy. It will permit you to get out of debt faster than making payments on your own, and the information will not stay on your file 10 years, as it does with a bankruptcy. If you are deep in debt and cannot make your monthly payments — and plan not to use credit in the future — you can consider debt settlement. But know that it will negatively affect your credit score, which could make it harder for you to get new credit and even find a job or apartment. Additionally, you might pay more for things like car insurance.