If you've got a lot of debt that you are struggling to manage, you have probably heard the term debt consolidation. Debt consolidation is an interesting approach to managing debt that differs from things like debt settlement or bankruptcy. For the right people (those who can qualify and who think they can work with this radical approach), debt consolidation can be the first step to financial freedom. But there is one other thing most people don't tell you about debt consolidation. Done correctly, debt consolidation will actually improve your credit score. Debt consolidation is not the same thing as debt settlement, debt management, or bankruptcy. Debt consolidation actually sounds counter-intuitive. To consolidate your debts, you roll all of your debts together and then take out a giant loan to pay off the individual debts. In a sense, you exchange many smaller debts for one colossal debt. So how does that help? The idea is that if you have a lot of high-interest debts, you can re-organize and re-package them together into one large loan at a lower interest rate. For instance, if you take a bunch of credit card debts at rates of 16% to 20% and beyond and consolidate them in a loan for 10%, that translates into paying less every month. Even better (for debt-free thinking) you can pay the same amount you were already used to paying but because interest rates are lower, you're knocking out more of the principal with each payment. Bottom line: your debt gets paid faster. If you own a home, you can refinance your home and possibly re-package those debts at a very favorable, mortgage-type single-digit interest rate. Debt consolidation is not for everyone. Not everyone can qualify; if your credit is already battered, you may not be able to get another loan, much less a big one. Debt consolidation is easier if you own a house, but that's not required. Debt consolidation will not be available to everyone who wants it. But if you can consolidate your debt and you're considering that versus other financial options, you need to know that most debt settlement plans and certainly bankruptcy will leave a bad mark on your credit report. Debt consolidation can help it. Here's how. Your credit score is a moving target, a constantly changing number, which is calculated by three large organizations in the U.S: Experian, EquiFax, and TransUnion. All of these companies have a formula for your credit score and each formula is a little bit different. However, they all arrive at a number (your score) based on a variety of factors. One factor is how well you pay off the debt you have. This score is very heavily weighted, making up about a third of your overall score. It looks at whether you pay your debt on time or late and if you make payments or flake out. If you consolidate your debt you take out one new loan and then pay off a bunch of smaller loans. This hits your credit score favorably: you have paid off some loans....probably earlier than required. That's a good thing. Consolidated debt simplifies paperwork and will eventually save you time. Instead of having to receive and write checks for a dozen or more bills a month, you have fewer debts (although it's much bigger). This reduces the likelihood of late payments or missed bills. That also can help your credit score. Another important factor weighed in your credit score is how much credit you have available to you versus how much you are currently using. Being maxed out everywhere is bad for your credit score. If you have credit but aren't inclined to use every bit extended to you, that helps your score. If you consolidate your debt, you immediately pay off a bunch of debts. If those debts are credit cards, for instance, you still have available credit. In fact, you're just increased your available credit by paying off the card. That counts in your favor, too. Last but not least, the philosophy behind debt consolidation is one of re-organizing or re-structuring debt, not simply trying to walk away from it or get a court to force creditors to write it off. Although it may not be called debt consolidation when businesses do it, large companies frequently have to re-structure debt to operate more efficiently. It is a standard business practice, one that makes good financial sense, and its primary purpose is to be sure that all creditors are paid in full according to the terms of the loan. In other words, debt consolidation preserves your good name and your integrity. If you consolidate your debt, you credit report does not suffer. It is quite possible that the credit reporting agencies do not even realize that you are consolidating debt. As long as you pay off what you owe, how you manage your money is your business. Most other debt plans immediately go on your credit report. If you've tried to negotiate or settle a debt (work out a plan to pay less), expect that to get reported. Businesses want to warn each other that you might be the kind of person to make charges and try to find a way not to pay according to the terms you agreed to. Bankruptcy is even worse on your credit report. It can be reported to future creditors for seven to ten years after the event. Many potential lenders won't extend credit to you if you have a recent bankruptcy and even those who will may be very meager and demand exorbitant interest. After all, you're now a "high risk" borrower. The good news for everyone is that the credit score is a moving target. It changes constantly and no one event, whether it's a late payment or a bankruptcy, will affect your credit score forever. Think of your credit score as an encapsulated picture of how you handle your money: you get points when you manage it well and you lose points when you make financial mistakes. Do enough good things with your money and your credit will improve, even if you've made mistakes in the past. Here are some general rules of thumb for a good credit score: You must have and use credit. A person who has never taken out a loan or paid off a debt can be the most reliable person in the world but he'll have trouble getting a loan. However, you should have more credit at your disposal than you actually use. Maxing out is not a good thing. Pay your bills on time and don't miss payments. Don't default on a loan, skip out on paying a debt, or go into a program that tries to settle or negotiate your debt. This gets reported. Avoid bankruptcy, if possible. This is not always possible, but view bankruptcy as a last-ditch solution not a first choice.
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