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Impact of debt consolidation on credit score: The pros and cons
Impact of debt consolidation on credit score: When you use a debt consolidation loan to pay off multiple debts, such as credit cards, your overall credit utilisation ratio tends to fall.
Impact of debt consolidation on credit score: Borrowers opting for debt consolidation should keep in mind that it can have both positive as well as negative impacts on their credit score or CIBIL score, depending on how they manage the process and their finances.
Debt consolidation enables borrowers to consolidate all the loans into a new loan so as to repay it comfortably at a lower interest structure, without staring at any financial burden.
Here's how it can impact your credit score.
These are the key positive effects:
Lower credit utilisation ratio: If you use a debt consolidation loan to pay off multiple debts, such as credit cards, your overall credit utilisation ratio may decrease. This ratio represents the amount of credit you're using compared to your total available credit. A lower credit utilisation ratio can positively impact your credit score.
Fewer accounts: Consolidating multiple debts into one loan can reduce the number of accounts with outstanding balances, which can be viewed favourably by credit scoring models.
Some of the potential negative effects:
Hard inquiry: When you apply for a debt consolidation loan, the lender may perform a hard inquiry on your credit report. While one inquiry typically has a minimal impact on your credit score, multiple inquiries within a short period can lower your score slightly.
New credit account: Opening a new credit account for debt consolidation can temporarily reduce the average age of your credit accounts, which may have a small negative impact on your credit score.
Overall, debt consolidation can help improve your credit score if you manage it responsibly by making payments on time and reducing your overall debt burden. However, it's essential to carefully consider the terms of the consolidation loan and ensure that you can afford the payments before proceeding.
Frequently Asked Questions:
What is the key advantage of debt consolidation?
It leads to fewer accounts as multiple loans are converted into one loan, which is viewed favourably by the credit scoring model.
Does debt consolidation have positive impact only?
Debt consolidation can have both positive and negative effects on your credit score, based on how you manage the same.
Can debt consolidation affect credit utilisation ratio?
If you use a debt consolidation loan to pay off multiple debts, your overall credit utilisation ratio may decrease, thus positively impacting the credit score.
Does checking your credit report affect your credit score?
A short answer is, it does not. In fact, it is advisable to keep checking the score from time to time for accuracy.
Why should you keep credit card balance low?
Maintaining low credit card balances relative to your credit limit is likely to impact your credit score positively.
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