Does Debt Consolidation Hurt Your Credit?

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When you consolidate credit card debt, you’ll often save money and lower your monthly payments. But how does debt consolidation affect your credit?

In the short term, your credit score may dip a tiny bit. Medium and long-term, though? Debt consolidation doesn’t hurt your credit score. In fact, your score may dramatically increase afterwards.

Here’s everything you need to know about the impact of debt consolidation on credit scores.

How Does Debt Consolidation Affect Your Credit?

Here’s a look at what you might see immediately after debt consolidation and then later on down the line.

Short-term Effects

Any time you apply for a loan, there are two components of your credit score that might decline, though the effects are only temporary.

• New credit: When you apply for a new loan, your credit score will drop by a few points. That’s because your credit profile has a hard credit inquiry added.
• Length of credit history: The longer your average age of accounts, the better for your credit score. When you open a new account, that average age will drop.

While the impact does seem negative at first, they’re not much to worry about as time goes on.

Long-term Effects

Debt consolidation will likely boost your credit score in a big way, especially if you’ve got multiple credit card balances.That’s because any debt you’ve got in the form of installment loans doesn’t count against your credit utilization.

Here’s an example:

• Available credit: $10,000 in available credit.
• Balance: $8,000 balance
• Credit utilization: 80%
• Apply for a personal loan: You apply for an $8,000 personal loan to pay off your credit cards.
• Result: 0% credit utilization — a huge win for your credit score.

Opening a balance transfer credit card to consolidate your debt can also help to lower your credit utilization, as your available credit will increase from the new credit line.

Good To Know

Credit utilization accounts for a whopping 30% of your credit score, and experts recommend you keep it under 30%. A debt consolidation loan could zero out your balances and boost your score by more than 50 points.

Can Debt Consolidation Hurt Your Credit Score?

Before you open a debt consolidation loan, it’s good to have a clear picture of how it can affect your score based on what you do with it.

Debt consolidation will hurt your credit score if:

• You miss a monthly payment.
• You rack up new debt while still repaying the consolidation loan.
• You close old credit accounts — it’ll shorten your length of account history.
• Your debt consolidation includes a debt settlement.

Debt consolidation won’t hurt your credit score if:

• You make on-time payments each month.
• You don’t continue to overspend on your credit cards.

Pros and Cons of Debt Consolidation on Credit

3 Types of Debt Consolidation and Credit Impact

There’s more than one way to consolidate your debt. The way your credit score is affected will vary depending on which one you choose.

1. Debt Consolidation Loan

If you consolidate credit card balances, a personal loan will be the best thing for your credit score. That’s because credit utilization, which makes up 30% of your score, only applies to revolving credit, like a credit card, and not installment loans.

If you move your debt to an installment loan, you can drop your credit utilization to 0%, which can mean a big boost to your score.

Also, installment loans offer predictable repayment terms and often have lower APRs than credit cards, which makes managing your money much easier.

2. Balance Transfer Credit Card

If you’ve got good credit, transferring your debts to a balance transfer credit card is often the most powerful way to save money. Some balance transfer credit cards offer 0% intro APR between 21 and 24 months, meaning every dollar you pay on your card will go toward the principal.

How does that impact your credit? Opening a balance transfer credit card will decrease your credit utilization when you consolidate credit card debtt.

On the other hand, it’ll likely increase if you consolidate installment loans, since these aren’t factors in your credit utilization.

3. Debt Management Plan

If you can’t seem to be approved for a personal loan or a credit card to consolidate your debt, you can turn to a debt management plan (DMP). These are handled by a nonprofit credit counseling agency and will work with you to find the best solution for your debt.

The agency often negotiates with your lenders to reduce the amount of debt you owe. It’ll then roll all your requested debts into a single monthly payment.

DMPs aren’t harmful to your credit, per se. However, a note may be added to your credit profile stating that you’re working to pay off your loans through credit counseling. Individual lenders may also see that you’ve struggled with debt in the past, which can make it harder to open accounts with them in the future.

Is Debt Consolidation Right for You? 

Debt consolidation can be a smart move — but it’s not for everyone. Here’s how to tell if it’s the right choice for you.

It might be a good option if:

• You have multiple high-interest debts, like credit cards.
• You’d benefit from a lower interest rate.
• Keeping up with your monthly minimums feels overwhelming or even out of reach.
• You’ve got steady income that can handle your new on-time payments.
• You want a clear end date to your debt.

It might not be the best fit if:

• You have poor credit and can’t qualify for a loan, and are considering a DMP as an alternative.
• You tend to overspend and will likely acquire new debt on top of your consolidation loan.
• You only have one or two small debts that you can pay off quickly.
• The fees or interest on the new loan are higher than what you’re currently paying.
• The loan terms result in a monthly payment that’s unaffordable.

How To Protect Your Credit During Consolidation

As you consolidate debt, stick to the tried-and-true steps known to protect your credit. This means making on-time payments and avoiding multiple loan applications and credit lines in a short amount of time.

Your No. 1 Rule: Never Miss a Payment

If you do nothing else, never miss a payment.

It’s also wise to keep your current credit cards open after you pay them off — unless the temptation to overspend is too strong, or the annual fees aren’t worth paying. Maintaining a large amount of available credit is important for a healthy credit score.

Finally, you should regularly track your credit score to ensure there are no discrepancies or hints of fraud. If you see an error, contact the credit bureau who reported it to have it corrected.

Debt consolidation can be a game changer when it comes to making your finances easier to manage. It’s not a solution that fits everyone, but you can use it to get ahead of your debt — as long as you avoid taking on new debt too.

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