Can a Debt Consolidation Loan Improve My Credit Score?
In a previous article, we addressed the question of whether or not debt consolidation loan would lower your credit score. This is one of the most common myths about debt consolidation, but the truth is that this process, if followed correctly, can actually help a person improve their credit score.
How a Debt Consolidation Loan Helps
Debt consolidation works by giving a person a loan that is large enough to pay off all of his or her existing debts. The new loan typically comes with a lower interest rate and better payment terms than the borrower’s old debt, so the borrower can pay off their debts faster and with a lower monthly payment. While this can provide some desperately needed relief for a person who needs to free up some cash in his or her budget, it can also help their credit score.
When a person’s debts are paid off, several things occur that can effect his or her credit score. To start, the account’s notation changes from “active” to “paid in full”. This reduces the number of open accounts on a person’s report, making them appear to have fewer loans. Banks tend to like borrowers that have fewer loans, because they believe that this makes them less of a credit risk. People with a lot of loans tend to miss payments more often than those with just a few accounts.
Keep in Mind
In some cases, this change in status will reduce the effect that previous mistakes have on a credit score. While there is evidence that shows borrower’s credit scores improving after paying off an account that was previously delinquent or missed payments, there are also people who have done this and have not seen their credit scores effected. Remember that no one outside the credit scoring agencies knows the exact formula for computing a credit score, so all anyone can judge from is what happens when people pay off their loans.
Finally, several months after getting a debt consolidation loan, many people report that their credit scores are higher. This is usually because they have made on-time payments for several months. This improves their recent credit history, an area that most banks consider especially important when deciding on loan applications. Of course, in order to see this improvement it’s critical that a person make their loan payments on time and for the full amount.