Will Debt Consolidation Affect My Credit?

So you’ve been noticing that your credit card balances are getting higher and higher each month, and now you’re considering consolidating your debt to get things back on track. But you’re hesitant because you’re not sure how it works or whether it will impact your credit score. So you continue to juggle your bill payments as you look for answers. If you’re confused by all of the conflicting information that you’ve heard about debt consolidation, you’re not alone.

One of the most common questions asked by Canadians looking for help with their debt is, “Will debt consolidation affect my credit?” In short, the answer is yes...and no. There are different types of debt consolidation and each one will affect your credit differently. Debt consolidation simply means to combine multiple debts together so that you only have to make one payment each month. Let’s break down the different ways of consolidating your debt, and how each one affects your credit report and credit score.

1. Consolidation loans: There are by far the most sought after type of debt consolidation, and probably the one that you are thinking about. A consolidation loan involves taking out a loan from a bank or a financial institution to pay off all of your unsecured debts, and then paying off that loan with a single payment each month. Debt consolidation loans usually do not have a negative impact on your credit score, and may even help improve it if you make your payments on time each month. Unfortunately, these loans can be quite difficult to get, especially if you don’t already have excellent credit. Ideally, the interest rate on your consolidation loan should be lower than the interest rates of your current debts. If the consolidation loan that you are being approved for has a higher interest rate than most or all of your current debts, it may be worth considering other options as these loans can take a very long time to pay back. To learn more about debt consolidation loans, visit our website.
   
2. Debt Management Programs (also known as Debt Consolidation Programs): This type of debt consolidation is usually administered by a private credit counselling agency. Unlike consolidation loans, a Debt Management Program (DMP) will not pay off your debt for you. Instead it will combine all of your unsecured debts onto one program, and will negotiate with your creditors to have the interest rates significantly reduced or eliminated so that you can pay off your debts much faster. You will then be responsible for making one payment each month to the credit counselling agency, who will distribute that payment to all of your creditors to pay down your debt. Although the credit counselling agency does not report anything to the credit bureaus, your creditors may choose to report that you are on a DMP which could have an impact on your credit report and credit score. Once all of your debts have been paid in full through the Debt Management Program, any negative credit ratings on them will be purged after two years, and your credit score should start to improve. At that time, you will be debt free and able to rebuild your credit. For this reason, a DMP can be the ideal solution if you are not able to meet or make much more than your minimum payments each month, but don’t qualify for a consolidation loan. If you are interested in how a debt management program works, click here to learn more about it on our website.
   
3. Consumer proposals: This debt consolidation program not only allows you to combine all of your debts into one monthly payment, but it will also reduce the overall balance of your debt and stop the interest charges. It is administered by a Licensed Insolvency Trustee, who can tell you what amount of balance reduction and monthly payments you would qualify for. A consumer proposal will negatively impact your credit report with an R9 rating on each of your debts for the duration of it, plus one to three years after. This can be a good solution if you are struggling to pay off your debts, and would not be able to do so on your own for years to come. It is important to mention that not everyone qualifies for a consumer proposal, and if you own a home the equity cannot exceed the total amount owing on your debts. You can learn more about consumer proposals by visiting our website.
   

While some types of debt consolidation may affect your credit, they may still be worth considering depending on your current situation and your ability to pay off your debts. If you can only afford the minimum payments, and it would take you countless years to pay back everything you owe, it may make sense to have your credit negatively impacted for a few years while you complete a consolidation program, and then you are able start rebuilding your credit once you are debt free. This can be better than allowing yourself to continue to drown in debt for years to come because you’re afraid of temporarily impacting your credit. Also remember that if you have any debt in collections, your credit is already affected and can only be improved by paying off the debt.

If you’re not sure which debt consolidation option makes the most sense for you, take our DebtAnswers Canada questionnaire to find out. It’s completely private and requires no contact information to get your answers. In just a few minutes, you can find out which of these debt consolidation options is right for you. Visit www.debtanswerscanada.ca for more information.