Hundreds of thousands of Americans are in debt, some quite a bit more than others. Messages of “Consolidating your debt” fill the internet and late night TV targeting the stressed out insomniacs worried about their ever increasing payments each month. You may have seen these ads late at night too. You may have wondered though, “Will debt consolidation affect my credit score?”
The answer is yes. However, the manner in which you consolidate your debt will determine how your credit score is affected. Before getting into that, let’s discuss the intricacies of credit.
The main concept behind debt consolidation is to help you manage your payments so you can eliminate your debt quicker. By consolidating, you are taking several smaller debts and strategically combine them to create one singular payment that is significantly less than the many smaller ones. A VA loan is one of the best tools to do this as you can utilize up to 100% of the value of the home.
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What determines my credit score?
There are several factors that go into calculating your credit score. How long have you had your credit? How much credit do you have? What are the ratios of your revolving credit balances to credit lines? How timely have you made your payments? These are some of the factors that determine your credit score. The more obvious and general answer of course is, the more misuse of your credit, the lower your score will be.
How can debt consolidation help my credit score?
One of the factors in determining your credit score is the balance to credit line ratios. It’s widely known that the lower your revolving credit balance is when compared to your total line of credit, positively impacts your credit score. Therefore, using a fixed debt consolidation loan, such as a VA cash out refinance, will open up your credit lines and show the credit agencies you can manage your debt. Paying off enough of this debt can easily give you 50, 75 or over 100 points on your credit score.
How does my credit score affect me?
When applying for a VA loan, or any loan for that matter, part of the process of determining an approval or decline is analyzing the home owner's credit. This includes looking at the credit history, debt to income ratios and credit scores. The debt to income ratios can only be overcome by an increase in income or paying off debt. Thus, a debt consolidation loan can be an immediate fix.
However your credit score is directly related to your credit history. Meaning, what's happened has happened. The only hope at this point is that it's not too late to do something.
The minimum qualifying credit score for VA loans as considered by most lenders is 620. A few more lenders are now offering VA loans down to 600 credit score now. Below 600, the credit is salvageable if you're working with an experienced Mortgage Consultant that has knowledge in credit scores and repair. If your scores are in the 700's, you generally have nothing to worry about but keep in mind, if you have started to see your credit balances go up and even worse, the rates and payments with them, then more than likely your credit scores are starting to drop. The lower the credit score, the more chances either you will end up with higher interest rates or points (prepaid discount buy down to achieve a lower rate).
Often times rates aren't affected too much on VA loans but what will be affected is lender credits. These are profits available on certain rates offered to customers to help assist with settlement charges. The higher the rate, the higher the lender credits available. However, the lower the credit score, the lower the lender credit.
So any way you look at it, a lower credit score will cost you money...either at closing or throughout the life of the loan.
Is a debt consolidation a good idea?
Knowing that your use or misuse of credit can cause your credit scores to drop significantly and as a result, higher interest rates in the future, finding a way to quickly pay down your debts is a wise idea. When considering a debt consolidation, keep in mind the goal is to first help you manage your debt. Improving your credit score while taking advantage of the lower rates, lower payments and any tax benefits that come with a VA loan, are simply bonuses. VA loans may or may not be the right answer for you but as a veteran or Military service member consider yourself extremely lucky to have one of the best debt consolidation tools available in America.
Images from top to bottom, courtesy of Salvatore Vuono and Renjith Krishnan / FreeDigitalPhotos.net