Published By Credit Suite at March 16, 2016
Those blanket debt consolidation loans offered by debt consolidation companies can sometimes seem like an appealing way to manage both business and personal debt. However, debt consolidation has its drawbacks for both business and personal credit. Let’s talk a little about each.
On your personal credit report, debt consolidation can have several rather negative effects. Often when people use debt consolidation, they close all the credit accounts that they are consolidating. Often people convert their unsecured credit cards to a single installment loan.
For people who close accounts, the closing of those accounts generally hurts their credit score. Closing credit card accounts reduces their “high credit limit” and hurts their debt to credit ratio. They also reduce the number of open positive accounts they have, and reduce the variety of credit types they are utilizing.
Furthermore, the debt consolidation loan typically involves a hard inquiry on their credit report. All of these factors have a generally negative impact on a consumer credit score. The changes in credit utilization (debt to credit ratio) alone can cause a significant credit score drop, since credit utilization accounts for over 30% of a consumer’s credit score. The negative impact of consolidating debts can be drastically reduced by keeping the credit lines/credit cards open rather than closing them.
The scoring rules for business credit are different, but they serve the same purpose… so we can expect some of the same effects. If you keep your accounts open when consolidating business credit, it could actually boost your business credit scores because those accounts will show as being paid off.
If a business uses a debt consolidation company (versus a consolidation loan from a bank), this is likely to be viewed negatively by future lenders and investors. Debt consolidation loans from banks, however, are often quite helpful to businesses and usually do not have a serious negative score impact–as long as the consolidated accounts are not immediately closed.
For Businesses and Consumers:
The bottom line on debt consolidation is that it can be a real life saver if done correctly. Blanket debt consolidation loans that consolidate a large pile of either consumer or business debts into a single large debt are usually a bad idea because they take away other possible options for dealing with the debts. However, sometimes debt consolidation is a necessary and valuable tool that can help businesses and consumers restructure their debts into a more affordable and manageable form.