After doing the math, you’re convinced you’re doing everything you can to save up money. You took some loans in the past, and now it’s time to pay. But it feels like you can’t pay it all, no matter how hard you work.
It’s fair to pay back what you owe. What’s stressful about loans is interest, which compounds over time. And the more loans you take, the more complex it is.
Good news is, you can consolidate your loans. It combines all your debt into a single loan. And for larger amounts, the interest generally goes down a bit.
However, that doesn’t reduce the amount you owe. Consolidation often means taking a much bigger loan to pay all your other urgent loans. And the longer you borrow, the more you need to pay.
More payments increase your risk of paying late, which will hurt your credit score. But if you know what you’re doing, it could actually save that score.
So what are the consequences of consolidating loans?
Does Consolidating Loans Hurt Your Credit?
Let’s start with the purpose: why would anybody want to consolidate loans?
The quality of your financial decisions will determine your credit score. And the higher it is, the harder it is to keep it. If you’re risking a high score, you might still qualify for a loan with better conditions.
So you use that money to pay the others. Hopefully, the term will be long enough for you to earn the amount back and repay. Even though you’re risking getting into more debt, doing it successfully will boost your credit score.
Make sure your credit utilization rate doesn’t go up too much. You can increase your credit capacity by opening more credit lines, which reduces your history length short-term (and therefore your credit score).
There’s no direct way to do it, but consolidation still makes sense.
- If all you need is time to generate income, this is what you want to do
- Taking another loan counts as a hard inquiry, which slightly lowers your score temporarily
Where’s the problem, then?
Late payments. When you group your loans, the monthly payment gets bigger. And when interest compounds, your debt may even grow faster than you can earn money. The moment you over-extend yourself, you can’t win. Because it’s a linear income stream competing against an exponential pattern.
It creates unmanageable debt, which limits your financial freedom. More than a bad credit score.
But don’t worry. We have found four effective ways to consolidate loans without hurting your score. And they get you enough time to pay off.
4 Ways To Protect Your Credit Score With Loan Consolidation
We assume you have what it takes to fix the situation: saving habits, earning ability, and a lot of patience. If you think you’ve tried everything, here’s what you can do next:
#1 Secured Loans
We also assumed your score is high enough to get another loan with better interest. But what if lenders reject you? You might not have enough points to consolidate debt.
No matter your score, secured loans are accessible for everyone. If you have valuable assets (car, house, antiques…), you can use them for a secured loan, which will pay for your unsecured loan.
It’s smart because even with poor credit, you can borrow money and rebuild your score when paying on time.
What happens if you don’t? You lose your valuables. It also affects your credit score, although a bit less than unsecured loans.
Assuming you already have a repayment plan in progress, this option will work for you.
#2 Only Miss One
Your score tells lenders how likely you are to pay back. Is it a Yes or a No? It doesn’t consider the amount. Use that to your advantage if you see you can’t pay it back.
Imagine you have ten loans with different amounts each. The default strategy is paying them one by one. Let’s say you can’t afford the last three and you default on them. The credit bureaus will rate: “This person makes 7 out of 10 payments on time.”
Second option: you consolidate. You take a big loan that pays all the ten, but you don’t have enough money to pay for the one you just took. For the bureaus, that means you paid 10 out of 11 times.
90.9% VS 70%
See? You may owe the same, but it affects your score differently. Another difference is, you’re much more likely to miss another payment on a bigger loan. But because you extended your term, you can now use your time wisely.
#3 Start A Business
Look, you can’t pay your debt when it grows faster than your income. The only way to beat an exponential pattern is by using another exponential pattern. And once you have an automated business, you earn money regardless of your time at work (AKA passive income).
We know it’s easier said than done. Businesses take a lot of time and money to start. But these days, you can learn anything from the Internet from websites like these. And once you have that income stream, it pretty much lasts forever.
Now, businesses may require money to start. Here’s how you can get some fast without having to get a second job:
#4 Borrow From Retirement
Have you saved some money here? If you don’t even have a retirement account yet, this advice still works for you.
As you may already know, 401Ks are one of the tax-deferred accounts you can have (learn more about retirement plans here). Every year, you can contribute a maximum of $19,500 to your traditional 401K and another $6K to a traditional IRA.
You fund these accounts with PRE-TAX DOLLARS, and you don’t pay the IRS until you withdraw them at retirement age. HOWEVER, there is a trick to get them out now, tax-free:
You can borrow from your 401K at any age as long as it doesn’t cross the maximum limit ($50,000):
- If you have less than $20,000, you can borrow all of it
- If you have more, you can only take 50% up to $50K
That should be enough to pay for your loans. And this money you lend yourself is tax-free.
If you don’t have an account, you could create a 401K this year and start moving all your income there. Next, you get out that tax-deferred money and use it to pay for your loans.
Can you imagine earning without paying taxes? You can now repay, at least, 20% faster (depending on your income bracket).
But wait. It’s not free money. You DO pay taxes when you return the retirement loan plus interest.
If you don’t pay yourself in five years, NOTHING happens to your credit! Instead, the loan counts as a withdrawal. So your taxes and probably a 10% penalty (for being under 59 1/2).
At least you saved your credit score.
Is Loan Consolidation Worth It?
It’s almost always smart to consolidate your loans, even if your monthly payments go up. But just because you can save your credit score short-term, that doesn’t fix future debt issues.
Loan consolidation does NOTHING to solve your financial situation. You’re not a single dollar closer to repayment until you start working on your income.
Hopefully, this short guide has shown you that you have more time to repay than you think. But, please, use it wisely. Some people take the bigger loan, but they ignore their debt. So they spend the funds on personal expenses.
Don’t back off just because you’re ahead of time! You’re still behind your payments. Depending on how you use the loan, it can be an investment or a liability.