|Recent studies have shown that more and more New Zealanders are struggling to keep pace with their growing debts (source: Reserve Bank of New Zealand). For many, the opportunity of a debt consolidation loan has become more enticing, but not all New Zealanders are convinced the option is a safe one for alleviating debt.
It is a prevailing myth that debt consolidation loans are an inherent detriment to your credit score. Here’s what you need to know!
What is a debt consolidation loan?
Debt consolidation is a personal loan taken to pay down outstanding debts from other credit accounts or bills, consolidating all debts into one. As the name suggests, these loans are often taken when people have multiple debts they are struggling to pay, making it difficult to get back on top of their finances. Multiple outstanding debts, each collecting interest and, in some cases, late fees or penalties can cause a snowball effect that buries people in debt for months or even years.
In instances such as these, a debt consolidation loan can be particularly helpful. It streamlines debts and alleviates the pressure of tracking payment terms, late fees and interest penalties, effectively refinancing outstanding debts and reducing them to a single loan payment. Often, debt consolidation loans are made at a lower overall interest rate. This makes budgeting easier and saves people money over time.
Can a debt consolidation loan damage your credit score?
Provided that you make your debt consolidation loan payments on time, they will not impact your credit score negatively. While debt consolidation loans are not without their risks—the loans themselves won’t inherently improve the borrower’s spending habits and can become burdensome if additional debts are amassed while paying them down—your credit score will look at debt consolidation loans just as it would any other line of credit. In fact, bringing multiple lines of credit current with a debt consolidation loan, as well as making your payments on time, can actually give your credit report a bit of a boost.
How will debt consolidation boost your credit report?
Nothing benefits your credit score more than making timely payments on your outstanding credit. By taking a debt consolidation loan, you are often replacing multiple late payments with one that you’re still in front of, which has the double benefit of relieving late payments and providing the opportunity for punctual ones. For borrowers whose outstanding debt is primarily from credit cards, a loan can diversify your lending profile, which will reflect positively in your credit. Importantly, however, the best thing you can do with a debt consolidation loan is to treat it as an opportunity to reform and improve your spending habits, so that you avoid falling into the same debt traps in the future.