Loaning money is full of risks, and you can never truly tell if someone will be able to pay off the loans they take. This is why, to provide some security to lenders, experts generate a score that summarizes your credit report. The score constitutes information such as the amount of credit you have in your name, how long you have had it for and if you have been regular and consistent with your repayments. In this article, we are going to discuss the impact that debt consolidation can have on your FICO score.
What is FICO?
If you wish to take a loan or have a credit card, you need to understand what a FICO score is. A FICO score, in simple words, shows whether you will be able to pay off your loan or not. The number is calculated based on your credit history and all the information on your credit report. This score reflects the amount that is best for you to borrow, the interest rate, and how long it will take to pay off the loan.
The FICO score is not only beneficial to the lenders, but it also helps loaners get clarity. If they have tried hard to keep their credit score high, they might be able to get the loan they deserve. No company can deny the authenticity of your credit score and will have to be just when allowing a loan.
Importance of Your FICO Score
Your FICO score is more important than you think. It grants you access to credit that helps you get whatever you want. For instance, you might need loans to cover medical expenditure or credit to cover your basic utility bills. The possibilities of what you can do with your credit are endless.
A good FICO score can help you save a lot of money. If you have a good credit score, you might have the exclusive option of getting a lower interest rate. Since giving you a loan is not that big of a risk, they might not find it unreasonable to give you a lower interest rate. The riskier it is to provide you with a loan, the higher the interest rate you can expect.
The FICO score helps lenders judge how big of a risk it is to lend you money. Therefore, it is extremely important to take care of your FICO score and avoid doing anything that might impact it negatively. This leaves the audience questioning whether consolidating their loans can result in a bad FICO score.
Does Debt Consolidation Impact Your FICO Score?
To answer the question in simple words, yes. Debt consolidation does impact your FICO score. However, the impact can be both negative and positive. Let’s take a closer look at the consequences:
Closure of Accounts
Whenever someone applies for credit, the creditor can make a hard inquiry on your credit score. They want to check whether you are risk-free and if giving you credit would a good idea. Whenever you get a hard inquiry, your credit score goes down a few points. When people go for a debt consolidation, they look at different options and apply for multiple loans. This can lead to multiple hard inquires that result in the decrease of your credit score. However, the hit is only temporary and can go back to the way it was within a day. Moreover, if you have had multiple hard inquiries within a short span, the score may not be affected. The inquiries will amount to a score of one, which means that it does not make a big impact on your credit score.
If you want to avoid the hard inquiry altogether, you can easily contact different lenders without them inquiring about your credit score. You just need to do your research to ensure that you go to the right people with your applications. Get the complete information before you make your decision so that your credit score does not have to suffer.
It is common for people to have a higher credit utilization ratio after they consolidate their debts. When you have multiple credits, your credit utilization is low, but when you consolidate all of them together, you might have a much higher credit utilization ratio.
On the other hand, if you put together the credit of different credit cards and get a personal loan, your credit score and the utilization ratio can improve. The two types of debt, credit cards and personal loans, both amount to 10% of your FICO score. When consolidating your credit score, your credit utilization for the previous cards will go down to zero, which can help improve your FICO score.
Credit utilization can have both positive and negative impacts on your credit score.
Payment history is one of the biggest contributors to your credit score. Typically, your payment history amounts to 35% of your credit score. This can be an opportunity for you to improve your credit score. All you need to do is make the payments on time and be consistent with them. This way, you will be able to pay off your loans and build a good credit history.
Many people have difficulty paying off loans with a high monthly payment. This is when consolidating your loans make things easier. You don’t just pay off loans, but you also get to get a new loan at a lower interest rate.
Debt consolidation means bidding your old accounts farewell. When you pay off the loan, many people do not want to keep using the old accounts. They would rather use a new account that has no debt. This results in the closure of accounts. If you close multiple credit accounts, that can mean that you decrease the age of your accounts, and your credit utilization ratio increases.
This way, you impact your credit score, and it can go down significantly. It is better to leave your accounts open even if they have a zero balance. Doing so will not impact your credit score in any way.
If taking a debt consolidation is unavoidable, you must make sure that you make the right decision. Acquiring a debt consolidation can impact your FICO score both positively and negatively. However, the pros of debt consolidation greatly outweigh the cons.