Does a Debt Consolidation Loan hurt your credit if you close the accounts and pay just a loan to a bank?

Debt Settlement Vs. Debt Consolidation

Debt settlement and debt consolidation both offer ways of reducing your debt. Debt settlement eliminates part of your loans, while debt consolidation reduces interest rates. Even though debt consolidation has the least impact on your credit score, there are cases when debt settlement is a better option.

Lower Debt

The goal of both debt settlement and debt consolidation is to lower your debt. Debt settlement companies negotiate with your creditors to sometimes reduce the amount of your unsecured debt. There will be a fee associated with the program that equates to roughly 1% of the interest that you will pay if you continue to pay the creditors directly.

Debt settlement can reduce your debt 40% to 60%. A debt settlement program can also cut our payments by 40% in most cases making it easier to cope with your monthly budget. In most cases for a consumer in a debt settlement program they are typically debt free within 2-3 years that can be about half the time it would take in a Consumer Credit Counseling Program or a conventional debt consolidation loan.

Debt consolidation pays off your high interest debts with a low interest loan. Home equity loans provide the lowest rates, but after stretching out the loan over 20 years the 6% interest refinance winds up costing the same amount as a 21% interest credit card. A conventional bank loan will not pay off the debts but rather transfer the debt from one institution to another. This action appears to banks and mortgage companies as a last ditch effort on a consumers part to try and rectify a sinking situation. Many mortgage companies see debt consolidation loans as a sign of stress in your financial situation making it difficult for them to extend you credit in the future.

Credit Score Implication

Reducing your debts through debt settlement is a method to get out of debt in a short period of time relative to your credit history. You credit score will drop, making you ineligible for prime lending situations. You can apply for sub-prime credit after a year however the goal of a debt settlement program is to get out of debt not to create new ones.

Taking out a loan to consolidate your debt will have a major impact on your credit. Since your debt isn’t actually decreasing, you will be negatively hit on your credit for opening another account making your overall situation more overextended. Most debt consolidation loans are issued with the assumption that the problem debt will be paid off and then the accounts closed. However 98% of consumers that get a debt consolidation loan do not close the problem accounts but rather make things worse by incurring new debt on the paid off accounts. Now the consumer is faced with the debt consolidation loan in addition to the new debt on the other accounts that were previously paid off.

Financial Choices

No one financial choice will fit everyone’s needs. While debt settlement will have an affect on your credit report, additional loans may be too expensive. In extreme cases, debt settlement can help to avoid bankruptcy and costly debt consolidation loans. Many debts settlement companies report that about 50% of the debt that their clients put into the program is debt from a prior debt consolidation loan.