Our investigation into this matter divulged a huge discrepancy between the consumer interpretation of "bad credit" and a lender's. Consumers assume that making payments on time means they have good credit and being consistently late with payments causes bad credit. Although making consistently late payments will definitely cause a bad credit rating, payment history plays only a 30% role in the credit score criteria. Debt plays an almost equally important role.
Lenders view credit rating from the standpoint of the credit score. Debt can have an adverse affect on the credit score. Many people who believe they have "perfect credit" in fact have low credit scores and to a lender they have "bad credit".
Credit card accounts were the most common detractor we found for several reasons:
- If only minimum monthly payments are made for several months, the credit score decreases;
- Credit cards charged to their credit limit has a huge impact on the credit score;
- Too many open accounts will decrease the credit score;
- Too many recently opened accounts cause a decrease in credit score.
Many people, despite never missing a payment, have low credit scores and technically bad credit because of their debt. There were no derogatory trade-lines but the credit score was similar to people with a terrible payment history. Furthermore the financial cost of debt increases greatly when the credit cards are charged to their limit and only minimum monthly payments are made. Elimination of credit card debt stops both the financial cost of high interest, and improves credit.
If a consumer's credit score is severely impacted by debt it could place them in a catch-22 because of their debt they have bad credit and cannot qualify for a debt consolidation loan and without a debt consolidation loan they cannot eliminate the debt that is causing the bad credit.
If the consumer is a homeowner it seems they would be best off locating a home loan or mortgage refinance specialist that has programs designed for debt consolidation and can work around the low credit score.
If the consumer's credit score is already affected by debt, and the consumer is not a homeowner, they can investigate alternative options. If the credit score is already low the negative impact of the available will have little net impact.
