Debunking Myths on Debt Consolidation – Does It Harm Credit Scores

Financial consolidation provides debt relief for people having difficulty paying off debts, but claims of debt elimination may cause some individuals to choose it rashly.

What Is The Meaning of Debt Consolidation?

To begin with, what is debt consolidation? Why would someone want to consolidate their debts into a single, massive loan?

In general, debt consolidation entails paying off many debts with a single monthly payment instead of making multiple payments to various lenders every month. It does not always entail consolidating all the debts into a single loan.

The individual debts are repaid with each payment. A debt consolidation program's "debt consolidation" element consolidates a client's debts into a single monthly payment.

Myths Regarding Debt Consolidation

It can be tough to find one's way out of debt. With so many alternatives, each with varying benefits and expenses, deciding what to do can be challenging. This post debunks several prevalent misconceptions concerning debt consolidation and where to find a debt consultant in Canada. 

Debt Consolidation Will Ruin Credit Rating

Debt consolidation does not harm the credit score. However, it can temporarily impact the credit score.

In a DCP, the credit rating will typically reflect an R7 for each financial debt in Canada included in the program and for two years following completion of the program.

Most of those who qualify for a DCP have missed many payments, had accounts sent to collections and reached their credit limit. Therefore, the R7 rating has little to no bearing on their present position.

Two years following the completion of the DCP, the client's debts (and their R7 ratings) are removed from their credit report. Some clients begin to experience changes in their credit rating and credit score much sooner or after the program has finished.

In contrast, debt consolidation loans influence credit in three distinct ways.

Hard Inquiry

Upon applying for a debt consolidation loan, a "hard inquiry" is triggered on the credit report. When a lender checks the credit, including the credit score and credit history, these requests occur. A soft inquiry occurs, for instance, when the credit record or credit score is examined. 

A hard inquiry stays on the credit record for one to three years. Many hard inquiries may drop the credit score and signal to lenders that they are in financial distress and in need of credit.

Conversely, a debt consolidation loan may improve credit score by supporting the development of positive payment history. The loan's debts utilized to pay off on the credit record will seem to be paid in full. Second, begin making timely monthly payments to obtain a lower interest rate that makes the monthly payments more feasible. This causes an increase in credit scores over time.

Credit Utilization Ratio

The credit utilization ratio compares the total amount of credit used to the total amount available across all the credit accounts. As a debt consolidation loan pays off various obligations to free up credit, this ratio may improve.

Remember that debt consolidation, whether through a loan or a program, has no definitive effect on the credit score. The repayment practices will determine the credit score after obtaining a debt consolidation loan or enrolling in a DCP.

The second fallacy is that debt consolidation always results in lower interest rates.

To be worthwhile, debt consolidation loans should have a reduced interest rate. However, not everyone is eligible for reduced interest rates.

The credit score or debt-to-income ratio may be insufficient for a lender to grant a low-interest debt consolidation loan.

When it comes to a DCP, though, things are different.

A DCP only makes sense if the interest rate on each debt included in the program can be reduced or eliminated. This is intended to offer the client breathing room and a payment plan that enables them to catch up on payments and begin making a significant dent in their obligations.

Conclusion 

If the client's certified credit counselor cannot negotiate a reduced interest rate on their unsecured debts, they will explore alternative debt relief options with the client. Consequently, a DCP will always provide interest relief to clients, regardless of their credit score. In looking into developing a solution, it is also optimal to seek assistance from debt helpers in Canada. 

Find customized debt solutions for Canadians at DebtHelpers.ca. DebtHelpers.ca provide a variety of debt solutions and consultation services to assist in achieving the goal of becoming debt-free. Seek assistance from debt helpers in Canada today.