If you're in way over your head with debt, debt consolidation is one option for lowering your payments and getting out of debt more quickly. Debt consolidation doesn't normally affect credit scores, but it can interfere with the ability to open new credit accounts. If you're interested in debt consolidation, ensure that you're using a debt consolidation company rather than a debt settlement company. Debt settlement can harm your credit.
Debt Consolidation Basics
There are two ways to consolidate your debt. First, you can take out a loan such as a home equity loan to pay off your balances and then make regular payments on the loan. But consumers often consolidate their debt through credit consolidation companies. The company will work with your creditors -- sometimes reducing your minimum monthly payments or interest rate -- and you'll be required to write one check each month to pay all of your debts.
Consolidation and Credit
If you consolidate via a loan, your credit may improve when you pay off old debts, but it could also take a minor hit when you apply for the loan. Consolidation through a debt consolidation firm, however, won't typically affect your credit. Instead the three credit reporting bureaus will place a note in your file indicating that you've consolidated your debts and are paying according to an agreement. This won't lower your credit score, but it could make lenders hesitant to offer you additional credit. You might be unable to get a credit card or loan until you've paid off your debts.
Missing a payment to a debt consolidation company can have a much more significant impact than a missed payment on a credit card bill or loan. This is because one missed payment equates to missing a payment on all of your debts and, if the payment is very late, could be reported to the credit bureaus as a missed payment on numerous accounts.
Some consumers confuse debt consolidation and debt settlement. Debt settlement is a process of reducing your debts and paying an agreed amount, usually in one lump sum. You can do this yourself by negotiating with your creditors, but some people hire debt settlement companies. There have been numerous debt settlement scams in which settlement companies accepted payments from consumers for a settled debt but did not pay the consumers' creditors. If you decide to settle your debt, try doing it yourself first, and check the reputation of your settlement company if you want to settle through a settlement agency. Debt settlement can affect your credit, and the credit bureaus will note in your file that you have settled your debt.
Van Thompson is an attorney and writer. A former martial arts instructor, he holds bachelor's degrees in music and computer science from Westchester University, and a juris doctor from Georgia State University. He is the recipient of numerous writing awards, including a 2009 CALI Legal Writing Award.