How Does Debt Consolidation Affect My Credit Score?

Debt consolidation can help you lower your monthly payments and get out of debt sooner, but you should be aware of how it impacts your credit score. Applying for debt consolidation loans can cause a temporary dip in your credit score, but making on-time payments towards a debt consolidation loan can help you increase your credit score in the long-term. In summary, debt consolidation can help you build your long-term credit score when used properly.

Can Debt Consolidation Hurt Your Credit Score?

In the short term, debt consolidation can cause a dip in your credit score. When you apply for a debt consolidation loan or similar financial product, a hard inquiry is made on your credit file. This decreases your credit score temporarily. Applying for multiple new loans in a short period of time will cause multiple dips to your credit score. To avoid multiple impacts to your score, you should do your research, compare loan offers, and feel confident about your likelihood of approval before applying for a loan. A new credit account also lowers the average age of your credit, which can temporarily decrease your score. 

In the long term, if you continue to rack up credit card debt or put charges on credit cards after you pay off your balance, any gains from reducing your credit utilization will disappear and your score will suffer. Missed or late payments will also negatively impact your score, since payment history is one of the most important factors that determine your credit score.

It’s important to address any poor habits that contributed to your credit card debt in the first place. Unpaid debt can have a significant impact on your credit score, especially if it’s been sent to collections. If you manage your debt poorly and don’t pay it back on time, your credit score will suffer. Establishing healthy credit habits will not only help you stay out of debt, but improve your credit score over time.

Can Debt Consolidation Help Your Credit Score?

While debt consolidation will not help your credit score in the short term, over the long term it can help improve your score if used responsibly to pay off and stay out of debt. Improving your payment history is one of the key factors to improving your credit score. That said, it will take time for loan payments to show up on your credit report and see the benefits reflected in your score. Depending on how low your credit score is, how much debt you consolidate, and how much you're able to pay off each month, it's possible to see your credit score improve within a couple of months.

As you pay off your debt and lower your balance, your credit utilization ratio will decrease and your credit score will improve. Continuing to make your loan payments on time will also improve your credit score over the long term. There are debt consolidation loan options available with bad credit, but having a good credit score will set you up for long-term success. 

How Do Different Debt Consolidation Solutions Affect your Credit Score?

There are different methods you can use to consolidate your debt. You could use one of the following four methods for debt consolidation: 

• Personal Loan

• Balance Transfer Card

• Home Equity Line of Credit

• Debt Management Program

The pros and cons of these four main debt consolidation methods are outlined here:

Consolidating Debt with a Personal Loan

Pros:

• Typically requires a lower credit score to be approved than a balance transfer card

• Allows you to consolidate multiple bills into one monthly payment, helping you keep track of your finances

• Typically carries a lower interest rate than unsecured credit cards, helping you get out of debt sooner

• Can lower your credit utilization if you use it to consolidate unsecured credit cards

Cons:

• Can lead to more debt and lower your credit score over time if you continue to use your credit cards and rack up additional debt

• If you can’t make the monthly payments, late payments will damage your credit score

• Can have a prepayment penalty (check with your lender)

If you feel confident that you can make monthly payments on time, a personal loan may be the right debt consolidation option for you. Lenders will qualify you based on your credit score, so it’s important that you know your score when researching new loan options. Sign up for Borrowell to get your free credit score, quickly compare loan offers, and see your likelihood of approval for new loans available to you.

Consolidating Debt with a Balance Transfer Card

Pros:

• Often offers a significantly lower interest rate for a set period of time i.e. 0% APR for a fixed number of months

• No prepayment penalty

• Offers flexible payments

Cons:

• If you don’t pay off your debt before the promotional period ends, you will be left with a much higher interest rate on the remaining balance (likely similar to the interest rate you were trying to reduce in the first place)

• Can lower your credit score because of high credit utilization

Consolidating Debt with a Home Equity Line of Credit

Pros:

• Often offered at a lower interest rate than a personal loan since it’s secured with your home as collateral

• Typically a revolving loan, meaning you can withdraw exactly what you need and only pay interest on what’s borrowed at any given time

Cons:

• Application requires a hard credit check, which will cause a dip in your credit score

• If you can’t make your payments you risk losing your home

• If used irresponsibly, you can end up in more debt, which can hurt your credit score and put your in a precarious financial position

Consolidating Debt with Debt Management Programs

Pros:

• Signing up for a debt management program (DMP) doesn’t have a direct impact on your credit score

• Can be beneficial for those with extremely high levels of unsecured debt who are struggling to make ends meet

Cons:

• Usually involves negotiating to pay less than the full amount on your cards, which can initially hurt your credit score

• If your DMP requires closing other credit accounts, that can cause a temporary dip in your credit

• Noted on your credit report but removed after completing the program

• Administration fee to set it up and an ongoing monthly administration fee while you’re in the program (not-for-profit agencies will have lower fees)

The Bottom Line

If used responsibly, debt consolidation can help you pay off your debt sooner and improve your credit score over time. Certain debt consolidation methods can even help you pay off debt on a low income. A higher credit score can help you qualify for loans, credit cards, and other financial products with lower interest rates in the future. 

A debt consolidation loan can help you build an established history of on-time payments and reduce your credit utilization. A debt consolidation loan is a great long-term way to build your credit without opening a bunch of credit cards. Applying for a debt consolidation loan or other financial products, however, will cause a temporary dip in your credit score. Do your research to decide which debt consolidation method is best for you, make a plan to pay off and stay out of debt, and continue to monitor your credit score and credit report to track progress over time.