Most individuals consider easy financing options available in the ever-evolving lending landscape, like credit cards, two-wheeler loans, loans against securities, etc., to meet varied financial needs. However, the weight of multiple debts can affect the borrower’s financial well-being. Therefore, many individuals consider consolidating their debts using a Personal Loan for debt consolidation. Debt consolidation refers to combining multiple loans or debt balances into one new loan available at a lower interest rate comparatively. A debt consolidation loan helps to reduce the overall financial burden.
How does Debt Consolidation Impact Credit Scores?
A credit score is a powerful metric that indicates an individual’s creditworthiness, impacting their ability to secure loans at affordable interest rates. In India, the credit score can be between 300 (lowest) and 900 (highest). Generally, lenders ask for a credit score of 700 and above. If individuals can maintain a higher credit score, they can enjoy a loan at favourable terms, like low-interest rates, flexible repayment tenure, high loan amount etc. A debt consolidation loan also impacts the credit score. Here are some key points to understand the impact of debt consolidation on borrowers’ credit scores:
Hard Inquiry
Lenders look at borrowers’ credit reports whenever they apply for a loan. Lenders make a hard inquiry called pulling the applicant’s credit report to check their creditworthiness. This can lower the credit score by a few points. However, the impact is minimal and a temporary hit.
Credit Utilisation
A lower credit utilisation ratio impacts borrowers’ credit scores positively. When borrowers consolidate debts, it can lower the overall credit utilisation ratio as they pay off a significant portion of their outstanding balances.
On-time Payments
Debt consolidation serves as a tool to effectively manage and repay debt. Making timely payments after debt consolidation can gradually enhance the credit score. It is important to note that the payment history carries the most weight (35%) in determining your credit score. It is necessary to make on-time payments towards the loan EMIs after consolidation. Only consolidating debts without modifying spending habits may provide temporary relief. Financial discipline after consolidation can help to boost your credit score.
The smartest way for debt consolidation is to start by listing your current credit card payments and loans and applying with a lender offering online loan approval on debt consolidation loans. Include the interest rate, minimum monthly payment and total remaining payments in the list. You can decide on the debt consolidation loan by comparing different lenders’ interest rates.
Conclusion
Saving on interest costs and simplifying the monthly payments are the primary motives behind debt consolidation. With proper knowledge of debt consolidation and its impact on credit scores, borrowers can safeguard their creditworthiness and make informed decisions. Initially, borrowers may experience a temporary decline in their credit scores. However, this initial drop can be acceptable as the borrower consistently makes timely payments and refrain from accumulating additional debt, gradually improving their credit score.
