If too much debt has damaged your credit score, then consolidating that debt into a single loan can be the first step towards solving the problem. By transferring your various debt balances into a single loan, you can simplify the management of that debt and often get a lower interest rate. When debt consolidation is used as part of an overall commitment to reduce debt, it can be a key ingredient for improving your credit rating.
Using Home Equity for Debt Consolidation Loans
One option for home owners is to use equity in their homes as the basis for consolidation loans. In order to do this, your house needs to be worth significantly more than the remaining balance of loans against the property. There are notable advantages to using a home equity loan for debt consolidation, but also an important caveat.
The advantage of using home equity to consolidate debts is that it can significantly reduce your borrowing costs. For one thing, interest on mortgages, which include home equity loans, is often as cheap as a borrower is likely to get. For another thing, interest on mortgages is generally tax deductible, which can further reduce the effective interest rate you are paying.
The potential drawback of using home equity to make existing debts more manageable? Like any mortgage, a home equity loan is secured by your home. So, if you are unable to make your loan payments, the lender may foreclose on your home. This is why some people prefer to use unsecured personal loans, despite their higher interest costs, for consolidation loans.
Shopping Around Pays Off
Whatever type of debt consolidation loan you decide upon, be sure to shop around for the best loan terms. What are you looking for? The lowest interest rate for the size and type of loan you choose is one thing. Another important consideration is a monthly payment that fits into your budget and allows you to pay off your debt within a reasonable period of time.
Stop the Bleeding! Don't Take on More Debt
Debt consolidation loans can make debt burdens more manageable, but they will only help you improve your credit in the long run if you stop taking on new debt.
For example, a debt consolidation loan may help you pay off your existing credit card balances. With those balances zeroed out, you may feel the temptation to start using those credit limits again. However, this would mean doubling up on debt - you would still have to make payments on the consolidation loan, plus you would have a whole new set of payments on the fresh credit card debt. This not would not only add to your existing debt burden, but it could put your house at risk if you become unable to make payments on a home equity loan.
So, along with consolidating your debt, you need to commit to following better financial habits in order to improve your credit standing. This means following a budget that does not include taking on more debt, and making all your payments on time. The combination of consolidation loans and a change in habits can be the right recipe for better credit scores.