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How Debt Consolidation Affects Your Credit Score

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In a Nutshell

You may have heard that debt consolidation can help you get back on track financially. But you’re not alone if you don’t know what debt consolidation is, how it works, or what your other debt-relief options are. In this article, we’ll explain how debt consolidation can help you save money by lowering your monthly debt payments and the interest you must pay over the life of a loan. We’ll also explore how debt consolidation affects your credit score.

Written by Attorney Kassandra Kuehl
Updated October 11, 2021

You may have heard that debt consolidation can help you get back on track financially. But you’re not alone if you don’t know what debt consolidation is, how it works, or what your other debt-relief options are. In this article, we’ll explain how debt consolidation can help you save money by lowering your monthly debt payments and the interest you must pay over the life of a loan. We’ll also explore how debt consolidation affects your credit score.

What Is Debt Consolidation?

Debt consolidation involves combining multiple debts into a single account. You can do this through a debt consolidation loan, a debt management plan, or a balance transfer credit card. You can use one loan or card to pay off your other debts, so that you can focus on making one monthly payment, hopefully at a lower interest rate. Or, you can work with an accredited, nonprofit credit counseling agency to roll your debts into a single account that the agency will manage on your behalf.

There are different kinds of debt, and not all debts and loans can be consolidated. Unsecured debt like credit cards and medical bills can be consolidated. But secured debt like a mortgage or auto loan generally cannot be consolidated, only refinanced.

Is Debt Consolidation Right for You?

Debt consolidation can be very helpful for some borrowers, but it’s not right for everyone. If you have healthy financial habits, are able to pay your bills on time, and have a good enough credit score to get a personal loan with a lower interest rate, you may be a good candidate. If you have poor credit but you can make a single monthly payment consistently, consolidating your debt through a debt management plan is probably your best bet. 

Also, if you’re having trouble keeping track of your monthly payments and due dates or you have a lot of high-interest debt, consolidating your debts can provide many benefits. If you qualify for a lower interest rate, you’ll save money in the long run, and more of your monthly payment will go toward the principal rather than paying the interest.

You’ll also only have a single monthly payment to worry about, which makes it easier to make on-time payments and avoid missed payments. In addition to making your life easier, this arrangement can also help boost your credit score. Plus, your monthly payment may be less than what you were paying before, which means you’ll be saving money every month, too. 

Evaluate your finances.

When considering debt consolidation, first gather as much information as possible. Put together a list of your debts, identifying the creditors’ names, amounts owed, and interest rates. Consider your other expenses and income as well. Once you have a firm grasp on your financial situation, you can then determine whether a debt consolidation plan could provide you with relief.

The process of evaluating your finances and your options is sometimes easier said than done. It can be difficult or overwhelming to figure out what you owe. Fortunately, there are accredited, nonprofit credit counseling agencies available that can help you. Their counselors can help you review your credit report and advise you about your options for debt repayment. Reputable credit counseling agencies employ credit counselors who are trained in consumer finance. Stay away from agencies that promise they can erase your debt. While debt consolidation can save you money, it won’t erase your debt.

Pros and Cons of Debt Consolidation

As with all debt-relief options, debt consolidation has both benefits and drawbacks. Some of the pros are:

  • You can lower your interest rate, which can help you save money in the long run.

  • You will streamline your monthly payments, which makes it easier and less stressful to make sure that you pay your bills on time.

  • You decrease the chances of missing payments, which helps you keep a healthy credit score.

  • You may have lower monthly payments that feel more manageable.

Some of the cons are:

  • There may be additional costs, such as an origination fee for a personal loan, fees for a debt management plan, or a balance transfer fee on a balance transfer credit card.

  • If you’re able to lower your monthly payment but not your interest rate, you may end up paying more overall in the long run. This is often the case for borrowers who have bad credit.

  • Not all debts can be consolidated.

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Debt Consolidation Options

There are several ways to consolidate your debt. The three most popular options are debt consolidation loans, credit card balances transfers, and debt management plans.

Debt Consolidation Loans: Personal Loans and Alternatives 

You can take out a new line of credit (such as a personal loan or a second mortgage) and use the proceeds to pay off your other debts. If you have high-interest debt like credit card debt, and you’re able to get a lower interest rate on a personal loan, this can be a great way to save money over the life of the loan. The catch is that you’ll need a good credit score to get a lower interest rate. You’ll then make one monthly payment on your new consolidated loan instead of multiple payments on multiple accounts. 

If you decide to go this route, there are other benefits. For example, personal debt consolidation loans can potentially help to improve your credit by diversifying your credit mix. Personal loans are installment loans whereas credit cards are revolving credit. A good credit mix includes some of both. This shows lenders that you can handle the responsibility of repaying different kinds of credit.

Credit Card Balance Transfers 

Another debt consolidation option is a balance transfer credit card. A balance transfer credit card allows you to transfer your other higher-interest credit card balances onto a single card with a lower interest rate. The lower rate may only be available for an introductory period, so you’ll want to pay off your balance during that time. If you don’t want to open a new card, you can see which of your current cards has the lowest interest rate and transfer your other balances onto that card.

The drawbacks of this debt consolidation method are that there is often a balance transfer fee and you’ll need to make sure you can get a card with a low APR and a high enough credit limit to make this approach work.

Other Options

If a personal loan and balance transfer card don’t sound like good options, don’t worry. There are other ways to consolidate your debt:

  • To enter into a debt management plan (DMP), you’ll work with an accredited, nonprofit credit counseling agency. A credit counselor will draft a plan to repay your debt. They can negotiate your interest rates and monthly payments with your creditors on your behalf. Instead of paying each debt every month, you’ll make a single payment to the administrator of the DMP, who will distribute the funds to your creditors. There is often a set-up fee and a small monthly fee for DMPs. This is a good option for those who don’t have good enough credit to take out a debt consolidation loan at a favorable rate.

  • If you have a number of student loans, you may consider student loan consolidation. Student loans are a unique kind of debt, and they can’t usually be consolidated like other unsecured loans.

  • A home equity loan or home equity line of credit (HELOC) is an option that allows homeowners to borrow against the equity in their home. This is often possible at a lower interest rate than credit cards. Similar to a personal loan, you’d use the proceeds of this line of credit or equity loan to pay off your higher-interest debt, then focus your efforts on repaying the equity loan or line of credit.

Debt Consolidation and Your Credit Score

Because traditional debt consolidation usually requires getting a new line of credit (unless you enter into a DMP), taking this approach will affect your credit score — sometimes negatively, sometimes positively. Your credit score is a numerical value that gives lenders a sense of how well you manage credit based on your credit history. It’s important to understand how debt consolidation will affect your credit score so you can make an informed decision about your options.

Hard Inquiries 

There are two types of credit report inquiries: soft inquiries and hard inquiries. A soft inquiry is when you look at your own credit report or a lender reviews it to pre-qualify you for a loan. These don’t impact your credit scores, but hard inquiries do. A hard inquiry is when a lender views your credit report to decide whether to issue you a line of credit. 

While hard inquiries will cause your credit score to drop a little, that dip is only temporary. To reduce the damage to your credit score, don’t apply for several new types of credit at once. If possible, get pre-qualified for the loan or card you’re seeking so that you know you’ll be eligible for the loan before you make a hard inquiry.

Average Age of Credit

Another factor in determining your credit rating is the average age of your credit accounts. This differs from the length of overall credit history. The first time you took out a loan or credit card, you established your credit history. But, the average age of credit looks at how long each individual account has been open. It makes up 15% of your credit score.

If you get a new line of credit, your average age of credit will decrease, which can cause your credit score to drop. While this change probably won’t be significant, it’s worth keeping in mind.

Credit Utilization Ratio 

The second-largest factor when determining your credit score is your credit utilization ratio. It makes up 30% of your credit score. This ratio is determined by looking at how much of your revolving credit (such as credit cards) you’re currently using in relation to how much total credit you have available. 

Let’s say that you have two credit cards, one with a credit limit of $2,000, and another with a limit of $4,000. Your overall available credit is $6,000. Now, let’s suppose that you owe $1,000 on the first credit card and $2,000 on the second credit card. In total, you owe $3,000 or half of your available credit. This means that your credit utilization ratio is 50%. This is considered high and will hurt your credit score. It’s better to keep this ratio below 30%.

Lenders view a lower credit utilization rate more favorably than a higher one because it shows that you still have available credit and aren’t maxing out your cards. When you open an account to consolidate your debt, this ratio may change. If you decide to get a personal debt consolidation loan to pay off your credit card debt and you don’t add new charges later to your credit cards (or close the accounts), your ratio should decrease, which will be good for your score.

Payment History 

The largest factor in your credit score calculation is your payment history. This makes up 35% of your credit score. This is why it’s so important to make all your debt payments on time. If you don’t, you’ll risk hurting your credit score. Missed or late payments may signal to lenders that you have difficulty paying your debts. This might make them more likely to reject your credit application or to charge you a higher interest rate.

Let's Summarize...

Debt consolidation offers borrowers a streamlined way to regain control of their finances, lower their monthly debt payments, and save money on interest. It is not without its drawbacks, though. Some debt consolidation options come with fees or costs. And some borrowers may not be able to get a lower interest rate, which means they may pay more in the long run even if their monthly payment is lower. Debt consolidation can have a positive or negative impact on your credit score, depending on which method you choose and how responsible you are with any new credit you may assume. 

If you aren’t sure if this is the right option for you, contact a credit counseling agency to get advice from a qualified financial counselor. Accredited, nonprofit credit counseling agencies offer consultations for free.

Written By:

Attorney Kassandra Kuehl


Kassandra is a writer and attorney with a passion for consumer financial education. Outside of consumer law, she is focused on pro bono work in the fields of International Human Rights Law, Constitutional and Human Rights Law, Gender and the Law. Kassandra graduated from Universi... read more about Attorney Kassandra Kuehl

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