Credit Basics for Debt Consolidation

Debt consolidation involves combining outstanding debts into one debt, which often can result in lower monthly payments.

The main purpose of debt consolidation is to put you on a road to paying off your debts at a faster rate while at the same time, making lower monthly payments. Using a debt consolidation plan usually helps improve your credit as well, since most creditors report payments received under this type of loan as prompt payment.

When you default on debt, you fail to make timely payments or follow other terms of the loan. There are two types of defaults: monetary and covenant (sometimes referred to as non-monetary). When a consumer fails to make any payment due, it is considered a monetary default. When a consumer fails to follow through on any other terms of the loan, it is considered a covenant default.

After the lender has accelerated the debt and the consumer has failed to pay the full amount due, the lender then becomes eligible for insurance benefits. The debt is then converted into monetary default.

Bankruptcy is the term that describes the court proceedings a person must go through to relieve the debts they are unable to pay their creditors.

There are three types of bankruptcy: Chapter 7, Chapter 11, and Chapter 13.

• Chapter 7 is a liquidation bankruptcy. It cancels or discharges certain debts by selling off particular types of property for your benefit. However, most people are able to keep the property they need to go on with their day-to-day lives.
• Chapter 13 is a reorganization bankruptcy where some or all of your debts are paid over time by using your income.
• Chapter 11 bankruptcy is geared more toward businesses that are having financial difficulty. It helps them in reorganizing their debts. Individuals who file a Chapter 11 bankruptcy usually have debts in excess of the Chapter 13 limits or have substantial non-exempt assets such as property.

In the United States, Equifax, Experian, and Trans Union are the three major credit bureaus that provide nationwide coverage of consumer credit information. Many national lenders report consumer credit information to all three. However, smaller banks, most credit unions and other credit grantors may report to only one, or none. Therefore, the information you receive from one credit bureau may not be the same as what you would receive from another credit bureau.

Payments must be at least 30 days late before they can appear on your Credit Report. Even though a payment made within this timeframe may not show up on your credit report, late payments can cause a number of fees or increases in interest rates with the lender directly. Therefore, it is best to pay your bills as soon as possible or in a timely manner after receiving them.

Depending on the type of negative data reported, there are a few different timeframes that a negative item will appear on a consumer's credit report. Usually, late payments (payments made 30 days or more past the due date), foreclosures, and collections will appear for 7 years. With bankruptcies, a Chapter 13 will also appear for 7 years, while a Chapter 7 will appear for around 10 years.

A lender will refer to your credit report to see if you are the type of person who will repay the loan, in full, within the time specified. While searching your credit report, lenders are looking for information that suggests you pay your bills on-time. Even if your credit report has up to two late credit card payments or one late installment payment, you can still have a credit score that is good, meaning you may be likely to still get a loan. However, if your credit report shows late payments of 60 days or more, late mortgage or rent payments, or outstanding debts (such as judgments or liens), you may fall into the bad credit category which will make it hard for you to receive a loan.

A lender will also look at your existing debt to make sure that repaying the loan you are about to take on is within your means. Most lenders say that non-mortgage debt payments should not exceed 10-15 percent of your take home pay each month. If your debts are currently exceeding this percentage, you may want to pay some of the remaining debts off before you apply for another loan.

Lastly, every time someone other than yourself requests your credit report, a note of that request is made on the report itself. If there are a large number of requests within a short period of time, the lender may think that you are applying for a loan because of financial difficulty or you are taking on more than you can handle.

A lender figures your credit score (FICO score) by taking your credit history and measuring it against a database of habits in the general borrowing population. That, in turn, determines whether your tendencies match those of borrowers who default on debt, declare bankruptcy or find themselves in various types of financial difficulties.

When determining how high a credit score will be, the following five characteristics typically separate good credit from not-so-good credit:

• Late payments in the past. People who have failed to make timely payments in the past are more likely to do the same in the future.
• How you have used your credit in the past. If you have one or more credit cards that are maxed out or close to it, you are more of a risk than a person who has a high limit but is not anywhere close to using it up.
• The length of your credit history. People who have had credit for a long time generally pose less of a borrowing risk.
• The number of times you have applied for credit. The number of times you have applied for loans, credit cards or other debt instruments may count against you when wanting to receive yet another loan.
• The number of different types of credit you have. Someone with a combination of installment and revolving loans is generally less risky than someone who has only a secured credit card.

Credit scores are a number roughly between 300 and 800. A number higher than 660 will almost guarantee a consumer a loan. Anything between 620 and 660 is not bad either, but a consumer may need to convince the lender that a loan to them would be worth it. If a credit score is below 620, receiving a loan may be difficult.

Of course, exceptions are sometimes made if the credit report has incorrect, incomplete, or not enough information on it. An unusual event, such as a job loss or extended sickness, may excuse borrowers as well, depending on the lender.

Federal law has made it illegal to use an alternative social security number when applying for credit. By using another social security number and new identification you cause the credit bureaus to generate another report for a person that does not really exist, and then use that new report to obtain credit. One of the problems with this technique is that it requires that you lie on applications for credit, which in most states is a criminal offense.