Credit and Debt Consolidation: Disadvantages of Debt Consolidation, Your Credit Score

Credit and Debt Consolidation

If you are in debt, and having trouble paying your bills, you may be able to lower the cost of getting a loan, or decrease the amount of interest you are paying, by consolidating your debt. This can be done through a bank loan, a home equity line of credit, or by going through a credit counseling service. Consolidating your debt is something that you can do fairly easily the first time, but it may be difficult if you have a low credit score – for example, if you have made late payments, defaulted on a loan, or have a charge off on your credit report. If you own your own home and have equity in it, you may be able to consolidate your debt through a home equity line of credit. Or you may be able to consolidate through a bank consolidation loan to pay of all of your creditors.

Debt consolidation may also have a negative effect on your credit report if you get a loan, because more loans do not look good on your report. This should be a temporary effect, as your credit score should improve once you have paid off your existing debt and have more available credit, but you want to make sure to be making on time payments on all of your bills.

Disadvantages of Debt Consolidation

While there are many advantages to debt consolidation, there are a few concerns anyone should be aware of before consolidating.

You need to watch out for scams and non-profit credit counseling companies which are actually for-profit companies, as well as things which are actually a disadvantage to you – sometimes the benefits which a DMP can provide are actually benefits you could get yourself from the lender if you just ask, for example on a student loan, in some programs after a certain number of on-time payments, your interest rate is lowered a little bit. If you go with a debt management program or consolidate your student loans with a bank or other lender, you start over with the time period, so it can actually take longer for your interest rate to go down.

A disadvantage to debt consolidation through a second mortgage or a bank loan is that this is usually a secured loan. If you do not pay this bill, you can lose your home. Also, you are still in debt, and usually still in the exact same or a slightly lower amount of debt, just shifted around. Many people respond to this debt consolidation as if they have no more debt, and go out and charge up their cards again. Thus, it is easy for a person in debt to end up in even more debt after they consolidate, and there are only so many times you can consolidate.

Another disadvantage to a debt management program is that you cannot get new credit during this time. For some people, this is a good thing, as they must learn discipline, but emergencies do happen and expenses occur. As well, some debts may not qualify for the debt management program, and so you will still have to make multiple payments each month. A disadvantage in the event that you get an increase in income, through a raise or a large income tax return, is that some debt management programs do not allow you to make extra payments ahead to your debts. If you send them an extra check, they might simply hold that in an account for your next month's payment. Many consumers using a debt management program simply save any extra money in an emergency fund.

How Your Credit Score Can Affect Your Consolidation

Your credit score is also called your FICO score, which gets its name from the Fair Isaac Corporation, the company which does the math to determine your credit score. The score is based on a very complicated algorithm, which is itself based upon a variety of factors. These factors include how much credit you have available, how much you owe, what your payment history has been like, the length of your credit relationships (longer seems to be better, so keep that credit account from when you were 20 open), and any charge-offs or bankruptcies which appear on your account. Your credit score can also be affected by recent inquiries on your credit, and if you have recently opened a credit account. This information is compared against every other American who has a credit history of any form, and everyone gets a credit rating. This score tells lenders how likely you are to pay back a loan.

Copyright 2007 Credit and Debt Consolidation