In a little bit of a debt pickle right now? We'll cover the ways to prevent your credit score from being affected by debt consolidation.
Consolidating debt is a practice used in Singapore to help Singaporeans and permanent residents juggle many high-interest loans when they find it challenging to fulfil the required payments.
It is essential to be aware of the eligibility requirements for a debt consolidation loan.
You must have an outstanding balance that exceeds 12 times your monthly salary, and you will need all records of money owed when applying to lenders or financial institutions who offer these types of loans.
In this article, we'll cover the following:
- How debt consolidation affects credit score
- Ways to consolidate debt
- Alternatives to debt consolidation
Why consolidate your debts?
There are a few reasons why you might want to consolidate your debts in Singapore. Maybe you're struggling to make your monthly payments. Or maybe you're paying a lot of interest and you want to lower your monthly payments. Whatever the reason, consolidating your debts can help you get out of debt faster and save money in interest.
How debt consolidation affects your credit score
Is debt consolidation bad for your credit? Debt consolidation loans might hurt your credit, but only temporarily.
On the contrary, debt consolidation can improve your credit score over time. But in the short run, your credit score will take a hit.
When you consolidate debt, your credit score is reviewed which might affect your credit history. Consolidating many accounts into a single loan will reduce your credit usage ratio, affecting your credit rating. Some of the unsecured accounts might be suspended or closed depending on the bank's loan sum approved.
Debt consolidation can also affect your credit score in other varying ways. The following are different ways debt consolidation might impact your credit score, either favourably or unfavourably.
May result in hard credit inquiries
Credit inquiries are one of the most important factors in your credit score. A hard inquiry, often referred to as a credit pull, occurs when a creditor formally investigates your creditworthiness. Your credit score is lowered by a few points for each hard inquiry.
When you apply for debt consolidation loans at various institutions, your credit score may suffer. Luckily, when your credit score is determined, many hard inquiries within a specified period of time, anywhere from 14 to 45 days, are generally consolidated into one.
But if you're not careful, too many hard inquiries could mean you're a high-risk borrower and could lead to higher interest rates and lower loan limits. So if you're shopping around for a debt consolidation loan, make sure you do it within a short timeframe.
Lower average age of credit
One of the things creditors look at when considering you for a loan is your credit history, or how long you've been borrowing and repaying the money.
The longer your credit history, the better.
That's because it shows creditors that you're a responsible borrower who can be trusted to repay loans on time. But if you consolidate all your debts into one loan, your credit history will look shorter. And that could lead to a lower credit score.
New credit account
Opening a new credit account could result in a hard inquiry on your credit report. And that could lead to a small drop in your credit score. But more importantly, having a new account will lower the average age of your credit accounts. That's because when you open a new account, it becomes the newest account on your credit report. And that could lead to a lower credit score.
Lower credit utilisation ratio
The credit utilisation ratio is the amount of debt you're carrying compared to your credit limit. It's one of the most important factors in your credit score and determines whether you're a high-risk borrower.
A lower credit utilisation ratio means you're using less of your available credit, which is generally good for your credit. When you consolidate your debt, you may get a lower interest rate and increase your credit limit, which could lead to a lower credit utilisation ratio.
Improved payment history
Your payment history is one of the most important factors in your credit score. It's a record of whether you've made your payments on time and in full. When you consolidate your debt, you may be able to get a lower interest rate and make smaller monthly payments. This could lead to improved payment history and increased credit score.
Ways to consolidate your debt
Not all debt consolidation solutions are appropriate. Here are five debt consolidation options for different credit and savings situations:
A personal loan is an unsecured loan, which means it doesn't require any collateral. This can be a good option if you have a good credit score, as you could qualify for a low-interest rate. However, personal loans typically come with shorter terms than other types of debt consolidation loans, so you may end up paying more in interest over the life of the loan.
Balance transfer credit card
A balance transfer credit card is a credit card that allows you to transfer your existing debt to a new card. This can be a good option in case you have a high-interest rate on your current cards.
However, balance transfer credit cards typically come with a fee, usually around 3% of the total amount you're transferring. And, if you don't pay off your debt before the promotional interest rate expires, you could end up paying a lot more in interest.
Related to this topic:
Balance Transfer: How Does it Work and Should You Get One?
Understanding Balance Transfer: How Much Can You Really Save in Interest?
How a Balance Transfer Can Help You Pay Off Holiday Debt
Home equity loan
A secured loan is a sort of home equity loan, which means the lender can seize your home if you stop making payments. This can be a good option if you have a good credit score and are looking for a longer-term loan.
However, you'll need to have enough equity in your home to qualify for a home equity loan. If interest rates go up during the life of the loan, you could end up paying more in interest than you would with other types of debt consolidation loans.
A cash-out mortgage refinance
A cash-out mortgage refinance allows you to borrow more money than you currently owe on your mortgage. This can be a good option if you need a lot of money to consolidate your debt. However, you'll need to have enough equity in your home to qualify for a cash-out mortgage refinance.
Alternatives to debt consolidation
If you're not comfortable with taking on more debt, there are a few alternatives to debt consolidation that can help you get your finances in order.
Borrow against life insurance
If you have a life insurance policy, you could borrow against its cash value to repay your debts. This can be a good option if you need a lot of money to consolidate your debt. However, you'll need to have enough cash value in your policy to qualify for a loan.
Debt Management Program
A debt management program is a counselling program that helps you get your debts under control. This can be a good option if you have a lot of debt and are unsure how to repay it.
A debt management program will help you create a budget and a payment plan, and the counsellor will negotiate lower interest rates with your creditors. However, a debt management program typically comes with a fee, and it can take up to five years to pay off your debts.
Pay off debts on your own using the snowball method
The snowball method is a technique that allows you to pay off your debts one by one.
You'll start by listing your debts from smallest to largest, and then you'll focus on paying off the smallest debt first. Once that debt is paid off, you'll move on to the next debt on the list.
This can be a good option if you're motivated by small victories. However, it can take a long time to pay off your debts using the snowball method.
If you're unable to pay off your debts, you may need to file for bankruptcy. Bankruptcy can let you start over by erasing your debts. It will, however, have a negative influence on your credit history, and it can be challenging to get approved for a loan or a mortgage after you file for bankruptcy.
Debt settlement is a process that allows you to negotiate a lower payoff amount with your lenders in exchange for a lump-sum payment. This can be a good option if you're behind on your payments and don't think you'll be able to pay off your debts. However, you’ll need to have a significant lump sum ready. It's important to note that debt settlement will also have a negative impact on your credit score.
If you’re looking for a reputable and affordable debt consolidation loan in Singapore, look no further. Check out the best debt consolidation plans in Singapore so that you can get your finances back on track.
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