Friday, 24 June 2016

What Credit Consolidation Does to Your CIBIL Score

It is good for your CIBIL score if you have a good mix of credit including secured and unsecured loans as long as you pay them all off on time. But sometimes it is maddening to manage several different loans efficiently at the same time. If you have an overwhelming debt (like a student loan, personal loan, car loan, home loan and credit card bills) then remembering the due dates and repaying them diligently each month can be a challenging task. There is always a risk that you lose track and miss out a payment which will then land you into trouble. A single default will not only attract a hefty amount of interest but also tarnish your CIBIL report. This is where debt consolidation can come to your rescue.

What is Debt Consolidation?
As the name suggests, if you have numerous debts you can consolidate them all by taking one single loan and use its proceeds to pay off all your earlier debts. Now you need to make only a single payment to service this new loan every month. This process removes the hassle of making multiple payments and streamlines all your debt obligations. Moreover a longer tenure and lower interest rates on debt consolidation loans will reduce your EMIs and ease off your burden.

How to Consolidate Debt?
There are several ways in which you can consolidate your debt.
Balance Transfer: In balance transfer you opt for a credit card with a lower rate of interest and transfer all your debt balances on this card. Some companies even offer a 0% interest on the transferred amount for a period of 1 month. It is ideal in case you can clear most of your outstanding debts within this interest free period. That’s because once the offer period ends the balance transfer cards start charging a heavy amount of interest.
Personal Loan: You can also save a lot of money by taking a personal loan. For example if you were paying an interest rate of over 30% on credit card balances it makes sense to consolidate them by taking a personal loan at 18%.
Secured Loans: A much cheaper way is to go for secured debt consolidation loan where you offer your asset as collateral and get an even lower interest rate of upto 12%.
Home Loan top-up:  If you have maintained a good track record of paying home loan EMIs then you may also be eligible for a top up loan that can be used to pay off multiple debts. Such loans usually have a longer tenure of 5 years and therefore give you sufficient time to pay off the loan.

Does it affect the CIBIL score?
While debt consolidation is a quicker and more efficient way of managing debts, we need to understand its impact through CIBIL score check. Well, consolidation loans do improve your credit score.
If you make consistent on time payments on the new consolidated loan then your credit score (which might have dipped because of late payments on earlier loans) will improve in the long run. Missing payments will bring the CIBIL score down and defeat the whole purpose of consolidation.
When you look for consolidating your debt the new lender will pull your credit history to take a decision on your application. So initially the CIBIL score may take a hit because of a new hard enquiry, but the overall negative impact it causes is insignificant as compared to its benefits in the long term. When your credit report shows that all your previous outstanding balances are paid off, it will have a positive effect on the CIBIL score.
Make sure you do not close any of your old accounts even if they are paid off. You may be tempted to close them to prevent further spending but such an act will reduce your available credit limit. It will appear that you are a high risk customer since you have maxed out the limit. This will cause your score to dip. Keeping old accounts open helps in maintaining the unutilized credit limit and the length of the credit history both of which have a bearing on the CIBIL score.

Debt consolidation does not reduce your outstanding balances. But it surely brings back peace of mind by making it easy to handle credit.  And it is actually what you do after debt consolidation that has a greater impact on the score than the act of consolidation itself.


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