Does Debt Consolidation Hurt Your Credit?
Debt consolidation doesn’t necessarily hurt your credit, and in some cases it can help. Whether or not a debt consolidation loan hurts your credit score depends on how you manage the process. Understanding how it works and what impacts your score is key to making the right financial decision.
Looking for streamlined finances, simplified monthly bills, and a potential boost to your credit score? Debt consolidation is one way to accomplish all of the above, but it’s not a magic fix. The more knowledge you have before taking out a debt consolidation loan, the better equipped you’ll be to manage your loan responsibly.
Debt consolidation means combining multiple debts into a single monthly payment—usually through a debt consolidation loan or a balance transfer credit card.
- A balance transfer card allows you to transfer your debt to a low-rate balance transfer card. This can be a good strategy for saving on interest in the short term, but the rates are typically temporary and can rise after a short introductory period. The rates may also change on an ongoing basis and require discipline to pay off the balance before the rate increases.
- A debt consolidation loan is a fixed-rate personal loan used to combine multiple debts and payments into a single debt with a single monthly payment.
Consolidating your debt can help you simplify your monthly finances by reducing the number of bills you have to manage, like multiple credit card bills. It can also help you save money by lowering your interest rate, your monthly payment, or both.
Do Debt Consolidation Loans Hurt Your Credit?
Debt consolidation loans can affect your credit score both positively and negatively. Your credit score depends on a variety of factors that all work together and affect your score. Debt consolidation loans can impact many of those factors, potentially even boosting your score in the process. Keep in mind that debt consolidation alone does not automatically improve your score. The impact on your credit score also depends on which method you use to consolidate your debt.
How Debt Consolidation May Help Your Credit Score
- Improved Credit Utilization Ratio: Using a personal loan to pay off credit card debt can help reduce your revolving debt and increase the amount of credit available to you, lowering your credit utilization, one of the key factors in your credit score. When you consolidate existing installment loans it may not increase the overall credit you have available, and therefore may not have the same impact on your credit utilization ratio or credit score.
- More Diverse Credit Mix: Your credit mix refers to the different types of credit accounts you have—particularly how much revolving debt vs. installment debt you have. More variety in the types of credit you have can generally help your score. If you use a debt consolidation loan to replace some credit card debt, you’re adding an installment account to your credit profile, which could diversify your credit mix and potentially boost your score if your credit history is heavy on revolving accounts like credit cards.
- Stronger Payment History: Payment history makes up the largest portion of your credit score. A single, manageable payment can make it easier to stay current and avoid late payments, which can hurt your credit score.
How Debt Consolidation Can Hurt Your Credit Score
Like any credit product, debt consolidation can impact your credit score in a few ways. The good news is these are mostly avoidable and not unique to debt consolidation.
- Hard Credit Inquiry: When you open a new account, such as a debt consolidation loan, the lender will typically perform a hard inquiry on your credit report. A single hard inquiry will most likely not have a huge impact on your credit score, but it may cause a small dip for a few months.
- Average Age of Credit: Establishing a long credit history usually helps your credit score, provided you have a history of on-time payments on your open accounts. Taking out a debt consolidation loan will cause your average age of credit accounts to decrease, which may cause a dip in your credit. If you can keep your oldest credit card accounts open, this can help you avoid lowering your average age of credit.
How to Avoid Credit Score Damage from Debt Consolidation
To avoid hurting your credit when consolidating debt:
- Make on-time payments every month
- Keep old accounts open unless you’re having trouble paying the fees
- Avoid accumulating new debt on your paid-off credit cards
- Stick to your budget so you don’t fall behind on your new loan
It’s a good idea to revisit your budget regularly to keep your spending in check. Even though your payments are streamlined, you still have to stay within your budget to be able to make your monthly payment. Check out more tips on how to stay on track with your debt consolidation loan.
Final Thoughts: Will a Debt Consolidation Loan Hurt Your Credit?
A debt consolidation loan may cause a short-term dip in your credit score, but the long-term benefits often outweigh the initial impact, especially if you make on-time payments and avoid new debt. In fact, debt consolidation can help you improve your credit score over time.
If you’re ready to take control of your finances, checking your rate for a debt consolidation loan is a great first step. If you stay on track with your monthly payments, a debt consolidation loan can help you streamline your finances and may improve your credit score.
