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What Are the Risks of Debt Consolidation?

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If a debt relief strategy seems too good to be true, it probably is. Every approach has its own unique set of pros and cons — there’s no way to wave a wand and watch your debt disappear.

Eliminating your debt requires commitment and willpower no matter which method you use, including debt consolidation. There are always certain risks involved; your job is to figure out whether the potential benefits outweigh the potential risks, and how you can avoid the adverse effects of these risks.

At this point,  you’re probably wondering; what are the risks of debt consolidation?

Keep reading to learn more. 

How Debt Consolidation Works

First, let’s cover a brief primer on debt consolidation. The basic idea is taking out one loan to pay off all your high-interest debts. This allows you to focus on making a single loan repayment each month rather than trying to manage a handful of accounts. When successful, this strategy can also lower how much interest you end up paying.

The possible rewards of debt consolidation are simplifying repayment and reducing interest. But there are possible risks to consider — like these three in particular.

Risk #1: Your Debt May Keep Growing

Bankrate compares debt consolidation to gastric bypass surgery: “You get a new lease on life and you can lose weight, but it’s not a permanent fix if you don’t change your eating habits.”

Think about how you got into debt in the first place. If you take out a consolidation loan to wipe out $15,000 in credit card debt but continue using these cards, you’re at risk of winding up exactly where you started — or in an even worse financial situation.

You’ll also forfeit the potential benefits of debt consolidation if you start missing monthly payments, as this will cause your interest rate to rise and your credit score to drop.

Risk #2: You Pay More in Interest Over the Life of Your Loan

One of the major aims of debt consolidation is to reduce how much you’re paying in interest. If you can qualify for a loan with an annual percentage rate (APR) of 10 percent, you’ll likely pay less than if you were trying to repay five lines of credit with APRs ranging from 15 to 25 percent.

But you should crunch the numbers before signing up to be sure you’re actually saving money. If you opt for low monthly payments stretched over a longer timeline, you may end up paying more in total.

Risk #3: You Fall for a Debt Consolidation Scam

It’s in your best interest to vet your consolidation loan provider thoroughly before signing anything. Unfortunately, there are opportunistic scammers looking to take advantage of consumers seeking debt relief. Make sure you’re working with a reputable partner like a bank or credit union — or an online lender with a proven track record of legitimacy. Do your due diligence before making a decision so you can avoid scams.

Here are a few red flags to avoid when you’re comparing your options for consolidation:

  • The organization charges fees up front
  • The organization claims to have access to a special government program
  • The organization makes guarantees about the outcome of consolidation
  • The organization fails to disclose the terms of the loan clearly

Knowing the risks of debt consolidation will help you make an informed choice on whether it’s a viable strategy for your situation — and avoid common pitfalls, like the three mentioned above, along the way. Consolidating your debts can help you get on top of them, but it’s up to you to keep developing good financial habits along the way.

Michelle has been a part of the journey ever since Bigtime Daily started. As a strong learner and passionate writer, she contributes her editing skills for the news agency. She also jots down intellectual pieces from categories such as science and health.

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How Conventional Scores Are Stopping Most Millennials From Accessing Credit and How One Company Is Changing That

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Credit scores are a barrier to entry for just about everything for millennials. Trust Science® is taking new metrics into account to expand access to credit with Credit Bureau 2.0®

What’s Keeping Millennials From Accessing Credit?

The concept behind a credit score seems simple enough. It tracks your credit history to see if you’re someone that a bank or lender can trust to pay back a loan. However, conventional credit scores just don’t account for the way that millennials and Gen Z handle their finances.

Even where a person would be fully capable and reliable in paying back a loan, the lack of an established credit score can prevent them from accessing credit, or at least from getting as much as they should be able to. That leaves millennials without an on-ramp into the modern economy and it can also jeopardize access to other “credit gated” necessities like housing.

The way that conventional credit scores are calculated is complex but boils down to 5 essential metrics:

  1. Payment history
  2. Amount owed
  3. Length of credit history
  4. Credit mix
  5. Hard credit inquiries

You can start to see the issue for millennials when you look at what data goes into their credit scores. For one thing, younger people don’t have a long credit history. Even without other factors, simply being young and only having had so much time to build credit puts them at a disadvantage. However, millennials have also been tending to establish credit later in life compared with previous generations, putting them at a further disadvantage.

The most significant issue here is the credit mix. Different types of credit affect credit scores differently, and millennials generally don’t have a favorable mix. While they might have a credit card or two, they generally don’t have mortgages. These are the most beneficial type of credit to have on your credit report, and millennials really have that going against them.

The student loan crisis also plays a big role. Young people today have much higher student loan debts than previous generations, meaning they have a great amount of credit owed. Not only that, but many can begin to fall behind on payments and see that amount grow. This can quickly send a credit score spiraling out of control.

Student loans aren’t the only threat. When young, some people make poor decisions. They could find themselves making credit mistakes very early on and suffering the fact that those mistakes can haunt their score for seven years in general. That means someone at 25 is still paying for a mistake made at the age of 18, even if they’ve been on the up and up ever since.

It’s clear that conventional credit scores weren’t designed with the current landscape in mind and that young people are being negatively affected. But what exactly can be done about this? One company is changing the way that lenders look at creditworthiness to make it possible for millennials to mitigate these issues.

How Credit Bureau 2.0 Fixes Those Problems

Trust Science is an innovative fintech company that has developed Credit Bureau 2.0, a scoring service that acts as an antidote for lenders, offsetting the problems posed by conventional credit scores. Instead of seeing a lack of credit history, a few negative issues from years ago, or a poor credit mix and ending any credit application, Credit Bureau 2.0 considers a wealth of additional data to generate a more accurate credit score.

Credit Bureau 2.0 expands the data used to calculate credit scores, getting the borrower’s consented, permissioned data and/or acquiring Alternative Data in order to reach a more accurate credit score. For example, those applying for credit can use Trust Science’s Smart Consent™ app to divulge their information safely and confidently to Trust Science, which is working on behalf of the lender that is trying to reach a decision about the borrower. By doing so, young people or other people without a credit history in-country can let prudent financial decisions in other areas of their lives demonstrate that they’re trustworthy for greater credit.

The service is available to a wide variety of lenders, including auto lenders, installment lenders, and single-repayment lenders. It’s in their best interest to find more reliable, deserving borrowers to give loans to, so Credit Bureau 2.0 benefits both sides of the transaction.

Trust Science CEO Evan Chrapko says that “Credit Bureau 2.0 isn’t just about giving borrowers access to more credit than they would have had otherwise. It’s about recontextualizing financial data to give both sides–lenders and borrowers–a more accurate and reliable way to enter into loans in the modern economy.”

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