If you’ve been struggling to juggle your credit obligations, you may be considering debt consolidation. However, what would this mean for your credit score?
We find out whether there are any implications, we consider some advice for settling your old debt, and we offer tips for deciding whether debt consolidation is right for you.
Tip: Debt consolidation can help reduce your monthly repayments. Find out more.
Your credit score may ultimately improve
Paul Slot, managing director at TC Wellness, says that, just like any other loan, taking out a consolidation loan will trigger a hard inquiry on your credit report.
“This can decrease your credit score by a few points for a few months. However, if payments towards your new loan are made on time, your credit score will automatically improve while you’re paying off your consolidation loan,” says Slot.
This means that consolidating your debt will, ultimately, improve your credit score, and help you address your excess debt – on condition that you abide by your credit agreement.
Settle your old debt and close your accounts
Slot says that if you enter into a consolidation loan and you fail to settle your existing debt and close your accounts, you may struggle to stick to your credit agreements and your credit score could decline.
“Failing to close old debt means an increase in total debt. This is often the case with credit card debt. Consumers will repay the credit card debt but fail to close the account,” says Slot.
He points out that if you don’t close your old credit card accounts, or any other credit-bearing facilities, you may be tempted to use your accounts again and place yourself in more debt.
“This defeats the purpose of debt consolidation, which is to simplify and reduce your debt by placing it in a single account. If you don’t manage your additional accounts well, this could have a negative impact on your credit score,” says Slot.
When you close your old accounts, your credit score will take a dip. However, you should consider this a necessary step to protect yourself from falling into further debt. In the long term, if you consistently repay your consolidation loan, your credit score will improve again.
What else should you consider?
Slot says that when you take out a consolidation loan, your credit reputation should not be your first priority. Instead, you should ensure that you’re able to meet the repayments, and understand that you shouldn’t apply for any new debt until this is settled.
“Debt consolidation is only effective if the new combined cost of the consolidation loan is less than the sum of the current cost of debt,” he says. For instance, each existing debt carries a monthly fee, an initiation fee, and – in most cases – a monthly credit life cover premium.
“If the cost of the new consolidation loan exceeds your current debt cost, then you need to think twice before taking it out,” says Slot.
In addition, he points out that if the interest rate of the consolidation loan is the same as your current rates, or higher, then the cost of the consolidation loan will exceed the cost of your existing debt.
In this event, Slot says, rescheduling your debt repayments over a longer period will be the main reason for going ahead.
“While this may improve your cash flow, via, for example, a lower monthly instalment, the repayment period is normally extended,” says Slot. "When you’re considering a consolidation loan, you should do the math and make sure you’re better off with the loan than you are without it.”
If you have determined that a consolidation loan is right for you, you can go to this page to get started.