Many people use debt consolidation to address high levels of outstanding credit card debt. This makes total sense, as the average American household is carrying credit card balances totaling $16,000 from month to month. A balance that high leads to a significant amount of interest expenses each month, so it’s not surprising that debt consolidation is such a popular option these days. However, using a debt consolidation loan to dispense with high credit card balances can sometimes help borrowers improve their overall credit as well.
Credit mix is another factor the various credit-reporting agencies use to calculate a person’s credit rating. The credit bureaus view borrowers who successfully manage multiple types of debt such as credit cards, auto, and home loans more positively than those who only have credit cards and are having trouble with the balances on them. Taking out a new debt consolidation loan can help broaden your credit mix and have a positive impact on your overall credit score, especially if the only type of debt you currently have is credit card debt.
Broadening your credit portfolio won’t improve your overall credit rating considerably, however. Credit mix only comprises about 10% of your credit score; increasing the types of debt you’re carrying may give you a modest boost, but it won’t significantly improve your standing in the eyes of the three credit bureaus. Additionally, if you’re already carrying multiple types of debt, a debt consolidation loan may do little to help diversify your credit and will likely have negligible effects on your overall credit mix.
Avoiding Red Flags
Most consumers strive to maintain a good credit rating because they want access to credit from banks when they need it for major purchases, such as a home, a car, or a luxury vacation. However, sometimes borrowers inadvertently hurt their chances of obtaining new credit by sending mixed signals to lenders with actions such as seeking debt consolidation loans. If your credit is average and you unsuccessfully apply for multiple debt consolidation loans, lenders later on may deem you too great a risk for a mortgage or automobile loan. This may be especially true if your debt consolidation applications are combined with other problematic credit activity, such as sporadic late payments.
If you want to preserve your credit and avoid the kinds of red flags that can scare off potential lenders in the near future, proceed carefully when it comes to debt consolidation. Don’t apply for any type of loan unless you’re reasonably sure you can gain approval. If you do get a loan, be careful to follow through with your debt reduction plan. Anything you do that can be considered erratic or in poor judgment such as late payments or delinquent automobile Delaware loan title accounts, or reckless and erratic credit utilization, could make banks less willing to work with you in the future. Think about your credit rating as your reputation, and then do everything you can to protect it in everything you do and every decision you make.
Another way that debt consolidation loans can affect your credit is by tying it all up while you’re paying off the loan and limiting your flexibility to make important life purchases. Many borrowers take out debt consolidation loans with long payback periodsbined with low interest rates, this helps to reduce monthly debt payments and make them more manageable. However, as a result, they’re often saddled with a high level of outstanding debt for a much longer period.
While your monthly payments may be lower with a long-term loan, your ability to assume additional debt may also be limited. It isn’t likely that you’ll have the ability to take out additional loans for important life purchases. So, if you want to purchase a new car or your first home after you consolidate all your debts, you may have to wait until after that debt consolidation loan is paid off.