Does Debt Consolidation Affect Your Credit?
Debt consolidation loans can be a good solution to manage debt — they enable you to have one monthly payment amount and one monthly due date, rather than having to pay several different lenders at different times.
However, many people interested in a debt consolidation loan wonder how it will impact their credit.
Will a Debt Consolidation Loan Affect Your Credit Score?
In short, yes — a debt consolidation loan will affect your credit score. But, it could be for the best if you take the right steps.
How a Debt Consolidation Loan Can Help Your Credit Score
Aside from helping to reduce the number of monthly debt payments and saving money on interest, debt consolidation loans can help you eliminate debt over time. As you consolidate revolving debt, such as that associated with credit cards, you’ll also be reducing your credit utilization ratio.
Since credit utilization accounts for 30% of your credit score, a debt consolidation loan can actually help your credit by reducing your overall amount of debt. In fact, nearly 70% of consumers who consolidated their debt saw their credit scores improve by more than 20 points.
Additionally, by making your monthly debt consolidation loan payments on time for the life of your loan, you’ll build a consistent payment history, which will help improve your credit score over time.
How a Debt Consolidation Loan Can Hurt Your Credit Score
If you make all of your payments on time, a debt consolidation loan can't hurt your credit in the long-term. While applying for the loan requires a hard inquiry into your credit, which could cause a slight dip in your credit score, it is only temporary. The exception would be if you are working with a credit counselor that requires you to close your accounts. However, sometimes life happens.
Just one missed payment could result in a negative impact to your credit score.
Payment history is the most important factor in calculating your credit score, accounting for 35% of your FICO score.4 But, only you can decide if debt consolidation is a good idea for your situation.
The Do’s and Don’ts of Debt Consolidation for Your Credit Score
If you want to use debt consolidation to your advantage and improve your credit score, do:
Talk to multiple lenders to ensure the best interest rate
Look for a lender willing to lower your overall repayment amount
Read the fine print — debt consolidation loans can result in a longer loan term, which can bring up the total cost — be sure to know exactly how much you’ll be paying over the life of your loan
Make your payments on time each month
If you don’t want debt consolidation to hurt your credit score, avoid:
Missing any payments
Canceling all of your existing credit card accounts
Running up credit card balances again
Applying for any additional loans
Life After Debt Consolidation
If you’ve taken out a debt consolidation loan, made all of your payments on time, avoid running up credit card balances again, and didn’t apply for any additional loans during the repayment period, then there’s a good chance your credit score improved.
Now, be sure to create good financial habits that you can stick to and commit to improving your credit score over time so you won’t end up in debt again.
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