Can a Debt Consolidation Loan Hurt Your Credit Rating?

By Gina Pogol
Mortgage Credit Problems Columnist

Debt consolidation can help you get out of debt and get your finances back under control. But it can also cost you. If you are using a new credit card or unsecured loan to consolidate debt, read the fine print. Chances are that teaser rate they have emblazoned all over the brochure is temporary, and the lender may be able to increase your interest rate at will.

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Lower Payments: Are You Really Paying Less?

Another way debt consolidation loans can cost you is by stretching out your loan balance. By taking the balance on a 5-year car loan and dumping it into a 10-year debt consolidation loan, you lower your payment all right--but it can cost a lot more. Take this example: Mr. Smith has a $10,000 car loan at 7% that he's been paying on for three years and he still owes $4,000. His payment is $198.01 and he will have the loan paid off in two more years. Now, some fancy mailer with a check in it shows up and he calls the 800 number. The saleslady tells him that he can use that check to pay off the car loan and the payment will only be ONE THIRD as much!!!!! She's not lying--if he uses that check, his payment drops to $57, but only because the $4000 has been stretched out into a ten year loan! The car will probably be in a junkyard somewhere by the time that loan is paid off. And the interest rate actually increases to 12%. So read that nasty little fine print even if you have to get glasses.

Debt Consolidation Can Hurt Your Credit

Credit utilization is a big deal with credit bureaus. It should be as low as possible, and paying off credit cards and closing them out can hurt you there. If you have ten accounts with a total limit of $20,000, and you owe $12,000, you are utilizing 60% of your available credit-not great, but not terribly bad either. If you close those accounts out and replace them with a $12,000 debt consolidation loan or home equity loan, your utilization shoots to 100%. Ouch. So can you leave the old accounts open? Perhaps--if your lender doesn't require that you close them, and if you can keep them open without using them.

Doing Debt Consolidation the Right Way

First, answering the first ad in your mailbox or inbox probably isn't the best idea. Unsolicited ads can be a risky way to deal with debt. You can get several offers from reputable lenders by completing a form right on this site. Make sure you read all the fine print--make sure there is no teaser rate or any other surprises. Finally, try to keep some accounts open--you can close your newer accounts but keeping the older ones is better for your credit history. Finally, leave your cards in the freezer or cut them up so you won't use them for impulse buys.



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