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Debt Consolidation Loan and Its Effect on Credit score

People face several unusual circumstances, which makes them take money or services from others and due to which they end up being in debt. To solve this problem of being in debt, there is a term called debt consolidation. Debt consolidation means taking a loan to pay off the remaining liabilities and obligations. Debt consolidation does not clear off the original loan, but it transforms the debt into consumer loans to a different lender.

Types of Debt Consolidation:

Secured and unsecured loans are the two primary divisions made for the debt consolidation loan. In a secured loan, the borrower submits one of its assets like house, car, etc. which turns into collateral.

Unsecured loans are riskier as such assets do not back the loan. These types of loans are difficult to obtain, and even if a borrower finds one, they tend to have a very high-interest rate and low amount to qualify.

In both cases, the interest rate is always lower than the price asked doe any credit cards, and the rates are fixed, i.e., they do not increase or decrease throughout repayment duration.

There are several ways of obtaining these debt consolidation loans. Some areas followed:

  • Debt Consolidation Loan

Like the banks and other lenders, the creditors agree to debt consolidation loans as part of a payment plan to the debtor who faces problems to account for the number and size of their debts. These are especially for people who look to clear off their many high-interest debts. 

  • Credit Cards

Another method to clear off all their prior credit card payments is to get a new credit card. It is advised to go for a new credit card that charges little or no interest for a period of time.

  • Home Equity Loans

Home equity loans are a different form of clearing off debts. In these types of loans, the interest rate is negotiable for taxpayers.

  • Student Loan Programs

The government has several programs to help the students of their country financially. They offer student loans. The interest rate of these loans depends on their previous loans record. Private loans don’t qualify here.

How dos debt consolidation work:

After a consumer is in massive debt, he/she can apply for a personal loan and abide by the guide for personal loan Singaporeto turn those debts into a single liability and pay off quickly. Payments are then made in the new debt till it is cleared off. Most of these consumers apply for the loan through their bank or credit card Company for the debt consolidation loan. 

Banks and credit card companies mostly agree to the loan if the applicant has a good relationship and payment history with them. Still, the consumer then mainly applies for a loan from debt consolidation private money lenders if they turned down. The lenders are mostly happy to agree to the debt consolidation loan as it maximizes the likelihood of collecting from the debtor. 

A person should always keep in mind that debt consolidation does not clear off the debt. Instead, it converts the debt into consumer loans to different lenders or types of loans. Those who do not qualify for these loans must not approach it and should go for debt relief. Debt relief reduces the consumer’s obligation rather than increasing the number of lenders.

Debt consolidation and credit score:

When a person applies for a debt consolidation loan, he/she pulls a lot of switches metaphorically to save themselves from further harm to their credit. The guides for debt consolidation in Singapore states that debt consolidation has several short-term and long-term effects on one’s credit score. Some of the short term effects are listed below.

  • New Credit Applications 

The problem that is being talked about here can even occur even before the consolidation. After anyone applies for a debt consolidation loan to a bank or private money lender, the lenders perform several hard inquiries on the borrower’s credit, which causes a lot of harm to the borrower’s credit score.

  • New Credit Account 

It is always kept in mind that when a person opens a new credit account like a credit card or loan, his/her credit score is also decreased by some amount. A lender always thinks of new credit as a new risk. This is the reason why one’s credit score takes an additional dip just after taking a loan.

  • The Lower Average Age Of Credit 

Having a credit account that is old and has a good history of on-time repayments gives rise to one’s credit score. Likewise, a person opening a new credit account lowers the average account age and, in turn, reduces the credit score for a while. 

As anyone can see, these previous points are harmful effects on a credit score from the debt consolidation loan. But loans from banks and debt consolidation private money lenders also positively affect one’s credit score. These effects are listed below:

  • The Lower Credit Utilization Ratio 

The lower credit utilization ratio refers to how the available credit that is being used falls when that person opens a new loan or debt consolidation account. It will increase the available credit. Lower credit utilization sometimes counters some of the adverse effects of opening a new account that were mentioned above.

  • Improved Payment History 

This effect is a time taking one because it works only when one makes the new loan repayments on time that gives a slow rise to the credit score. The payment history of one’s credit score is the most significant factor, and one should always keep in mind to pay on time.

Conclusion:

Debt consolidation means clearing off several debts and converting them into a single debt. Debt consolidation loans have low-interest rates. The debt consolidation loan mostly keeps an asset of the borrower as collateral. The debt consolidation loan sometimes improves your credit score for future loans and has some adverse effects on the credit score.

 

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