Will Debt Consolidation Negatively Impact Your Credit?

Editor’s Note: This post was originally published in May 2019. 

Most people who have debt are looking for a way out, ASAP! If you’re struggling to cover debt payments, you’ve probably considered all the different ways to reduce your payments and get out of debt faster: debt management plans (DMPs), debt consolidation, debt settlement or even bankruptcy. 

For a solution that can reduce your monthly payments, without destroying your credit, debt consolidation can be one of the best options. While debt consolidation doesn’t eliminate any of your debt, it can help you become debt-free sooner. Plus, it can help you improve your credit scores in the long run, as long as you make your monthly payments on time.

What is debt consolidation?

Debt consolidation involves using a credit card or a loan to pay off several debts. The “consolidation” part refers to the fact that you move several debts onto one account. As a result, you will have fewer monthly payments to manage. 

How can debt consolidation help you? There are a few key ways debt consolidation can help someone who’s in debt:

• Lower rates: If you move your debt to an account with lower interest rates, you can save money on interest charges. Because more of your money then goes toward your balance, you may also get out of debt faster. 
• Lower payments: There’s a chance that consolidating will reduce your total monthly debt payments. This can happen if you have lower interest rates, and/or if your repayment is stretched out over a longer period of time.
• Easier management: Rolling multiple debts into one account gives you fewer payments to make, and fewer due dates and balances to track.

With that said, it’s not a magic solution. Debt consolidation doesn’t erase any of your debt. So for some people, it just becomes a way to move debt around without actually paying it off. 

If debt consolidation isn’t available for you, perhaps because you can’t qualify for a new loan or because the payments are still too high, consider a debt management plan (DMP) instead.

How does debt consolidation impact your credit?

Debt consolidation will definitely have an impact on your credit scores. But many consumers falsely assume the impact is negative. 

The truth is that debt consolidation can initially cause your credit scores to drop. However, if you make your monthly payments on time, and you pay down your debt (instead of accruing new charges), your scores can improve drastically. Here’s what to expect:

• Hard inquiries: When you apply for a credit card or loan, your scores will take a hit. This is also known as a hard inquiry. According to FICO, each hard inquiry typically costs you five points or less. 
• Closing accounts: If you close an account after consolidating, you may see a drop in your credit scores. That’s because you may have less available credit. To minimize the impact, avoid closing old credit cards unless you fear you’ll be tempted to use them.
• Monthly payments: Your payment history is the biggest factor used to calculate your credit scores. If you make on-time payments on your consolidated debt, you can typically expect to see a slow increase in your scores. If you miss a payment, your scores can plummet quickly.
• Debt payoff: Reducing your total debt can help your credit scores improve significantly. If your interest rates are lower, you can pay off debt faster and see your credit scores rise faster. However, if you keep accruing new debt, your scores may not improve.
• Mix of credit: If you don’t have any loans on your credit reports, taking out a personal loan for debt consolidation may improve your “credit mix,” which makes up 10% of your FICO credit scores.

Common mistakes with debt consolidation

Debt consolidation can be tricky. So it’s important to approach it with caution and avoid these common mistakes that hurt your credit:

• Ignoring terms: Most people use balance-transfer credit cards to consolidate debt. But these cards tend to have intentionally confusing terms. For example, they usually come with a 3% or 5% fee on the debt you transfer. So if you transfer $5,000, your fee could be $150 or $250. If you don’t understand the terms, you could also end up losing your 0% APR period early.
• 0% APR traps: The 0% APR offer on a balance-transfer credit card will only last a limited time. After that, the APR can skyrocket up to nearly 30%. If you don’t have a plan for paying off your debt before then, you could end up deeper in debt than before, with higher interest rates. 
• Increasing debt: For some people, consolidating debt can feel like an invitation to charge up their balances on old cards. But if you keep accruing more debt, your finances will suffer, and so will your credit scores.

Debt consolidation can be a big win for your credit

In short, you can expect to see your credit scores drop a bit after you consolidate your debt. However, if you stay on track with your payments and reduce your overall debt balance, you can expect to see your credit scores improve.

Still not sure if debt consolidation is the best choice for you? An NFCC-certified credit counselor can help you figure that out. When you meet with a counselor (in-person, by phone or online), they will answer all of your questions about managing debt, and they can recommend the best solutions based on your exact situation.

Andrew Rombach is a Content Associate for Lendedu – a website that helps consumers and small business owners with their finances.