Does Debt Consolidation Hurt Your Credit?

Debt consolidation is the process of taking multiple payments from multiple debts and putting them in one place so you have fewer payments. In many cases, debt consolidation takes the form of a new loan or credit card balance transfer to pay off the old debt.

However, says Beverly Harzog, a credit card expert and consumer finance analyst for U.S. News & World Report, there are also debt management programs that will handle the payments for you.

“These allow you to make one payment a month without the need to borrow,” she says. “What you really have to watch out for are debt settlement companies that consolidate to help you pay less than you owe.”

On this page:

• How Does Debt Consolidation Work?
• Does Consolidating Debt Help Your Credit Score?
• Does Debt Consolidation Hurt Your Credit?
• Should You Do Debt Consolidation or a Balance Transfer Credit Card?

How Does Debt Consolidation Work?

“The key to debt consolidation is getting all your debt in one place,” says Harzog. “There are different ways to do that, but the principle is the same — fewer payments to deal with and hopefully getting out of debt faster.”

Here’s how debt consolidation works:

• Gather your debts: Start by figuring out which debts you have and the payments you make. This can include high-interest credit card debt across multiple cards for example.
• Find a way to get them in one place: You can get a personal loan and use it to pay off your smaller debts, open a new credit card and perform a balance transfer to a lower introductory rate, or contact a management or settlement company that will take care of it for you. For the most part, these types of debt consolidation require good credit ratings to receive worthwhile terms. If you have poor credit, a management company might be able to help. “Talk to a credit counselor,” Harzog recommends. “Go to NFCC.org and find a counselor near you that can help you consolidate without a loan.”
• Make your payments: Now that you have all your debt in one place, you only make one payment. With a personal loan or balance transfer, try to get rid of the debt as quickly as possible. If you’re using a company, you make payments to the company, and they send payments to your creditors, all of which can reduce the risks of late payments.

With your debt consolidated in one place, you have a better chance of keeping up with payments, and you might even have a lower interest rate, allowing more of your payments to go toward principal, rather than interest.

Does Consolidating Debt Help Your Credit Score?

“It’s possible to have good credit and a lot of debt,” says Harzog. “Especially if you’re making your payments on time and haven’t quite maxed out your credit cards.”

If you’re in that position, you have a better chance of being approved for one of the best debt consolidation loans or a credit card balance transfer with a low interest rate. You’re not likely to hurt your credit score too much, and in the long run, tackling the debt will help. Here’s how:

Payment Management

With debt consolidation, you reduce the number of moving parts in your financial life. You only have one loan payment to make instead of several, so you lower the risk of missing a payment. Because payment history is the most important aspect of your credit score, a missed payment can have an impact.

Consolidate your debt and you’re less likely to miss payments and you may be paying a lower monthly payment than you would otherwise. This is going to help encourage you to make on-time payments as well.

The bottom line is that all this will be positively reported to credit bureaus. On-time payments are essential for a good credit score. 

Budgeting

Your monthly payment is set and predictable when you’ve completed debt consolidation. This makes it easier to budget. Credit card balances come with varying payments, but if you use a debt consolidation loan, you don’t have to worry about a different monthly payment.

This certainty in your cash flow and budget can go a long way toward helping you maintain good habits that will protect your credit score.

Lower Credit Utilization Ratio

Another way debt consolidation can help your credit score is by reducing your credit utilization, says Harzog. Once you consolidate to a personal loan, the percentage of your credit card balances being used is lower.

Credit utilization is the second most important factor in your credit score, so making those improvements can be a big help. The less you’re using of your available credit limits, the better, score-wise. 

Even completing a balance transfer can improve your credit utilization ratio, says Harzog, because the new credit and new debt is taken into consideration and you’ve paid down your other credit cards.

Pay Off Debt That’s in Delinquency

If you’ve been struggling to make payments, the missed payments might be dragging at your credit score. Pay off the balances in collection or delinquency with a debt consolidation loan and they will become less important to your score over time, allowing you to see an improvement in your score.

Diverse Forms of Credit

Use a personal loan for your debt consolidation and you could increase the types of debt that you have.

“Adding an installment loan to the mix can improve your credit,” says Harzog. “With debt consolidation, you have a chance to show you can handle different types of credit, not just revolving lines like credit cards.”

Does Debt Consolidation Hurt Your Credit?

While debt consolidation done carefully can be a long-term benefit to your credit score, there are some downsides. You need to be careful of how you proceed in order to protect yourself from hurting your credit.

Hard Pull on Your Credit Report

Anytime you apply for a new loan, whether it’s for a credit card or a personal loan, there will be a hard pull on your report. Harzog says that a hard pull can impact your credit score by a few points. “It’s usually not too much, though,” she points out. “The loss of a few points can be made up for relatively quickly if you make your debt consolidation payments on time.”

You Might Continue Bad Spending Habits

One of the risks of debt consolidation is that it can free up your credit cards for more debt, warns Harzog. “You need to identify why you’re in this spot and work to fix the causes of the debt,” she says.

If you get a personal loan and pay off your credit cards, there’s a risk that you will just run up more debt on the freed-up lines of credit. When that happens, your credit score is at risk and you’re in more debt than you started with.

In order to avoid these issues, work on getting your spending habits under control and stay away from further debt spending.

Non-Loan Debt Consolidation

Using non-loan debt consolidation can have an impact on your credit score and credit history, too.

First of all, if you use a debt management company to make payments on your behalf, you need to provide accurate information so they turn the payments in on time. If the company misses a due date or doesn’t send the full minimum required, your credit could suffer.

Additionally, if you use a debt settlement company, you send your one payment a month to a third party who works to negotiate repayment terms. It makes things easier for you, consolidating your payment, but the reality is that you’re no longer paying your creditors. That’s how debt settlement companies leverage the situation.

“Debt settlement as a form of debt consolidation should only be attempted if your credit is already suffering,” says Harzog. “Otherwise, this will destroy your credit.”

Should You Do Debt Consolidation or a Balance Transfer Credit Card?

Getting a personal loan and doing a credit card balance transfer are both types of debt consolidation.

• A debt consolidation loan is an installment agreement. You get a new loan, pay off your existing debts, and then just make one payment each month for a set period of time.
• A credit card balance transfer, on the other hand, allows you to open a new credit card and move your current balances to the new card, usually with a low introductory interest rate. It’s a credit card, so your minimum payment fluctuates and there is no set timeline for repayment.

With a debt consolidation loan, you’re likely to pay an interest rate based on your credit score. You can usually qualify if you have fair credit, although you’ll pay a higher rate. Even with the higher rate, though, you might still save money by consolidating credit card balances.

Your credit card balance transfer can be helpful, especially if it’s 0% APR. All your payments go toward reducing your debt. However, you might have to pay a balance transfer fee, which can be costly. On top of that, the introductory period is limited, so if you don’t pay off your debt fast enough, the interest charges skyrocket at the end of the period.

“If you have good credit, you can get either a personal loan or a credit card balance transfer, usually,” says Harzog. “However, if you know it will take you more than a couple years to pay off your debt, stick with the debt consolidation loan. If you know you can pay off your debt within the intro period, consider a credit card balance transfer.”

Bottom Line: How Does Debt Consolidation Affect Your Credit

Debt consolidation can help you manage your debt and get back on your financial feet. And, if done right, it can even help you improve your credit score in the long run.

However, you need to be careful of the pitfalls. Realize that there might be a negative impact on your credit and choose the method of consolidation that works best for your situation. You may opt for credit counseling before making any big decisions. Other options include a debt management plan or participation in some other type of debt relief program. 

“Know what you’re getting into,” says Harzog. “Debt consolidation works really well when you understand your options and you’re willing to just focus on the debt and clean up any credit mess afterward.”