Credit can be a useful tool when used correctly, but if you’re not careful, the debts you accumulate can become a significant burden on your finances.
There are a number of ways you can reduce debt without getting overwhelmed, but one common strategy is debt consolidation, which lumps multiple credit accounts into one monthly payment. Here’s how it works — and the impact it can have on your credit score.
If you’re ready to get serious about your finances and get rid of some — or even all — of your accumulated debt, you may want to consider debt consolidation, suggested Kurt Brucker, private CFO at oXYGen Financial and advisor to many millennials seeking personal finance and career guidance.
“This is a good option for someone who has a ton of outstanding consumer debt including different credit cards, and are looking to simplify their situation,” he said.
Consolidating debt is essentially taking out a new loan and using those funds to pay off all your other lenders so you only have one payment to deal with. You may even be able to get a better interest rate than you would have been paying on the original debts, which means paying less in the long run.
“The main advantage of debt consolidation is to simplify your debt situation with only one payment,” he said. “It’s easier to manage because you’re no longer confused about how much debt you have out there and how many lenders. You have a single loan, which allows you to focus on making that one payment each month.”
According to Brucker, debt consolidation can have both short- and long-term effects on your credit score. You may see your credit score drop temporarily at first, he said but it will quickly go back up once you pay off the old debt and start making regular payments on the new account.
“Opening new lines of credit may hurt your credit score initially because it is seen as a potential risk to lenders,” Brucker explained. “However, once the account has been established and your spending doesn’t skyrocket, you should be able to have a lower credit utilization ratio, which in turn will improve your score.”
Remember, the most important factor in calculating your credit score is payment history, so as long as you make your payments on time and stick to your debt-reduction strategy, your score should improve quickly.
The benefits of consolidation are pretty straightforward, said Brucker, but don’t forget that the ultimate goal is reducing your overall debt. Consolidation helps many people by letting them focus on just one loan instead of several credit accounts.
“With only having to make one payment it’s easier to understand what you have in front of you,” said Brucker. “My advice for someone currently in debt is that they need to first take inventory of their financial situation. Once they’ve assessed their needs, then they could consider consolidation and accelerate the payment of their debt to get rid of it.”