Debt Consolidation And How It Affects Your Credit

Those blanket debt consolidation loans coming from debt consolidation companies can sometimes seem like appealing. They can feel like a great way to manage both business and personal debt. However, this species of financial solution has its drawbacks for both business and personal credit. Let’s talk a little about each.

Personal Credit

On your personal credit report, this sort of financial solution can have several rather negative effects. Often when people use debt consolidation, they close all the credit accounts that they are consolidating. Often people convert their unsecured credit cards to a single installment loan.

For people who close accounts, the closing of those accounts generally hurts their credit score. Closing credit card accounts reduces their high credit limit. And it hurts their debt to credit ratio. This can also reduce the number of open positive accounts they have. And it can reduce the variety of credit types they are using.

But There’s More

Furthermore, the debt consolidation loan typically involves a hard inquiry on their credit report. All of these factors have a generally negative impact on a consumer credit score. The changes in credit utilization (debt to credit ratio) alone can cause a significant credit score drop. This is since credit utilization accounts for over 30% of a consumer’s credit score. You can drastically reduce the negative impact of consolidating debts by keeping the credit lines/credit cards open. Do this, rather than closing them.

Business Credit

The scoring rules for business credit are different, but they serve the same purpose. So we can expect some of the same effects. If you keep your accounts open when consolidating business credit, it could actually boost your business credit scores. This is because those accounts will have a showing of being paid in full.

If a business uses a debt consolidation company, it may be the wrong idea. That’s because this is likely to be a move which future lenders and investors view negatively. This is versus a consolidation loan from a bank. Debt consolidation loans from banks, however, are often quite helpful to businesses. And they usually do not have a serious negative score impact. But that is only as long as your consolidated accounts are not immediately closed.

Debt Consolidation For Businesses and Consumers

The bottom line on this kind of solution is that it can be a real life saver if done right. Blanket debt consolidation loans might put together a large pile of debts into a single large debt. So, these can be either consumer or business debts. And they may seem like a good choice. But they are often a bad idea. So this is because they take away other possible options for dealing with the debts. However, sometimes debt consolidation is a necessary and valuable tool. And it can help businesses and consumers restructure their debts into a more affordable and manageable form.