Myth #1: Debt consolidation hurts your credit score
This is a myth that can stop people before they even get started. Debt consolidation does not need to hurt your credit score. If you consistently make payments on time each month until your debt consolidation loan is paid off, using this strategy could improve your score.
The “credit score” myth may have started because there could be a slight drop in your credit score when you first apply for a debt consolidation loan. That’s due to the “hard inquiry” the lender performs during the approval process, but this decrease is temporary.
Myth #2: Debt consolidation leaves you deeper in debt
Falling “deeper in debt” with debt consolidation happens when a consumer doesn’t change their spending habits, such as limiting credit card use after paying off their balances. Continuing to spend without sticking to a budget can result in new monthly credit card payments to go along with the payments on the debt consolidation loan.
Myth #3: Debt consolidation loans cost more
The idea that debt consolidation loans must cost more is misleading. Since debt consolidation loans typically come in the form of structured personal loans, they feature terms that are consistent and offer predictable payments. The misconception around higher costs may stem from the fact that those seeking to consolidate may have lower credit scores due to high credit utilization, which can lead to higher interest rates. However, comparing personal loan interest rates to those of existing high-interest debts often reveals consolidation is a financially savvy choice.
Myth #4: Debt settlement is cheaper than debt consolidation
At first glance, if it’s available as an option, debt settlement might seem like an easier and less expensive route since it involves paying off debts for less than the total amount owed to the creditor. However, when considering the broader and longer-term financial implications, debt settlement can end up being costlier. This method can significantly damage your credit score, making any future borrowing more expensive.
Additionally, if a creditor issues a 1099-C form for the canceled amount, you could be liable for taxes on this “income” or see a reduction in your tax refund, if any, further increasing the overall cost. In contrast, debt consolidation offers a more predictable, and often lower overall cost.
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It is important to consider the pros and cons of debt consolidation before diving in. It is a common and proven debt management strategy. You just want to make sure you set yourself up for success, and don’t encounter any surprises.