How Does Debt Consolidation Affect Credit Scores? By Amy Nutt At Isnare.com Ezine Articles

In these tough economic times, it is increasingly difficult to manage household finances and pay one's bills. Income is waning, and the general outlook on the economy is negative. The fact that many Canadian households are riddled with consumer debt doesn't help. Credit card or other consumer debt can carry very high interest rates, making even the minimum payments difficult to afford. To make matters worse, paying only the minimum amount due each month does nothing to help get you closer to paying off the debt completely. Being in debt can easily make you feel as if you are buried and unable to free yourself. If financial obligations and debt are weighing you down and making you feel buried, you may be considering using a debt consolidation service.

What is Debt Consolidation?

In a nutshell, debt consolidation is a service whereby individuals can take out a single loan to pay off all their various debts. While debt consolidation does not take away your debt, it does improve your situation by simplifying your debt into one single manageable payment. Most importantly, though, debt consolidation loans typically reduce the interest rate paid on your debt drastically.
Another form of debt consolidation focuses more on credit counseling. Credit counselors work as intermediaries between you and your creditors and are able to negotiate settlement of your accounts, many times for less than the original amount owed.

What is a Credit Score?

A credit score is a rating issued by credit reporting agencies that evaluates your general creditworthiness. There are three major credit-reporting agencies that issue credit scores in Canada. The scores are calculated by taking certain factors into consideration.

These factors include but are not limited to:
- Length of employment
- Number of credit accounts
- Status of credit accounts
- Debt to credit ratio
- Debt to income ratio

Credit scores are important because financial lending institutions use them to determine whether you are a good "risk" or not. If you have a very low credit score, you are not likely to be approved for a mortgage or other loan. On the other hand, with a very high credit score, you have a much better chance of being granted credit cards and being approved for consumer loans such as home mortgages, auto loans, student loans or personal loans.

Debt Consolidation's Effect on Your Credit Score

Many people are weary of taking drastic actions when it comes to credit accounts, because every single thing you do affects your credit score in some way. For example, every time you apply for a new credit card, your credit score is affected. If you pay your credit cards on time, (or likewise, late,) your credit score is affected. Perhaps the most relevant action, and the one that causes people to question whether debt consolidation can hurt their credit score is the following. Closing credit card accounts can actually have an adverse effect on your credit score. While you maintain your credit card accounts open, they count as "available credit." The more available credit you possess, the better you credit score will be.

How debt consolidation affects your credit score will depend chiefly on which form of debt consolidation you are considering. A debt consolidation loan that will allow you to pay your accounts in full and still maintain the accounts open, will not affect your credit score adversely). In fact, this scenario is likely to increase your credit rating. The second form of debt consolidation, however, will have a negative effect on your credit score as you will not be paying the accounts in full, and since the accounts will be closed, you will no longer have that credit. Depending on your situation, the tradeoff may be worth it.

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