Is Debt Consolidation Harming Your Credit? – Forbes Advisor


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If you’re having trouble paying your bills or want to get out of debt faster, debt consolidation could be a solution. But before going ahead with this method of debt relief, it’s important to understand what it does to your credit, how the process works, and your other options.

Here is an overview of how debt consolidation works.

How does debt consolidation work?

Debt consolidation is a form of debt relief that usually involves taking out a new loan to pay off previous loans, combining the debts – consolidating them – into one monthly payment. Debt consolidation can offer several advantages, such as lowering your interest rate, simplifying your monthly payments and getting out of debt faster.

If you’re trying to decide if debt consolidation is a good idea, start by looking at your overall financial life. Debt consolidation may be right for you if you’re having trouble paying your bills, aren’t comfortable with your current debt amount, or aren’t happy with interest rates (APR ) from your existing credit cards or loans.

However, it’s also important to be aware of how debt consolidation could affect your credit score. Take care to manage your credit score while paying off your debts.

How Debt Consolidation Affects Your Credit

Debt consolidation could impact your credit score, both good and bad. Below are five ways debt consolidation could positively or negatively affect your credit score.

1. It could lead to serious inquiries into your credit

Each time you make a formal credit application, the creditor conducts a thorough investigation, also known as a credit application, to check your creditworthiness. Each serious inquiry usually lowers your credit score by a few points. If you shop around and apply for debt consolidation loans from multiple banks at once, your credit might suffer temporarily. Fortunately, many difficult requests within a given period, ranging from 14 to 45 days, are usually combined into one when your credit score is calculated.

Remember that a thorough investigation is not necessary every time you speak to a lender or visit a website. It is possible to do your research and be prequalified for a loan without having to go through the difficult application process. Many lenders will allow you to shop for rates and prequalify online by completing a soft credit check, or soft draw, which does not affect your credit score. This allows you to take the first steps to see if you qualify for a loan, but without damaging your credit.

Before deciding to go ahead with a lender, read the fine print and make sure you understand whether or not you’re ready to have your credit checked with a thorough investigation as part of the loan application process.

2. Your credit usage may change

Creditors and rating agencies pay attention to your credit utilization ratio, which accounts for about 30% of your FICO credit score. Your credit utilization rate is the percentage of available credit you are using at any given time. For example, if you have a credit card with a credit limit of $15,000 and a balance of $4,500, your credit utilization rate would be 30%.

If your credit utilization ratio increases after debt consolidation, it could have a negative impact on your credit score. Using the example above, if you transfer the balance of $4,500 from your existing credit card with a $15,000 limit to a new credit card with a $7,500 credit limit, your interest rate The credit usage on this new card will be 60%, which could affect your credit score.

On the other hand, if you consolidate multiple credit card debts into one new personal loan, your credit utilization rate and credit score could improve. Credit cards and personal loans are considered two separate types of debt when evaluating your credit mix, which makes up 10% of your FICO credit score.

For example, let’s say you have three credit cards. Again, using the example above:

  • The first card has a balance of $4,500 with a credit limit of $15,000.
  • The second card has a balance of $2,000 with a credit limit of $10,000.
  • The third card has a balance of $5,000 with a credit limit of $10,000.

You would have credit utilization ratios of 30%, 20%, and 50%, respectively, for these three cards. (By combining the cards, your overall credit utilization is almost 33%.) If you combine these three debts into a new $11,500 personal loan, the credit utilization ratios for each of these three cards will drop to zero (provided you keep credit card accounts open and you don’t overspend on the cards), which could improve your credit score.

3. The average age of your accounts could drop

Another factor in determining your credit score is the average age of your accounts, or how long those accounts have been open. This shows the overall length of your credit history and represents about 15% of your FICO credit score.

If you open a new credit account as part of your debt consolidation plan, whether it’s a new balance transfer credit card or a new personal loan, the average age of accounts decrease and you may see a drop in your credit score. But depending on how many other credit accounts you have and your overall credit history, the drop may not be significant.

4. It can improve your long-term payment history

Payment history accounts for about 35% of your credit score. If you already have a strong track record of on-time payments, debt consolidation may not affect this aspect of your credit score. But if consolidating your debt into a new loan at a lower interest rate makes it easier for you to make on-time payments, debt consolidation could help improve your credit score in the long run.

5. It could tempt you to close accounts

If you’re going through the debt consolidation process, it can be nice to close your old accounts after a balance transfer or getting a new loan. But be careful. Closing a credit account could reduce the average age of your accounts or increase your credit utilization rate. Both of these actions can hurt your credit score.

After completing your debt consolidation process, consider leaving your old credit accounts open but with a zero balance. Keeping these accounts open and on your credit report can be good for your credit score, as long as you’re not tempted to use them to rack up more debt.

Ways to consolidate your debt

There are several ways to consolidate your debts:

  • Debt consolidation loans. Debt consolidation loans are a type of personal loan available from banks, credit unions, and online lenders. With this type of loan, lenders can pay off your debt directly or provide the borrower with the money to pay off their outstanding balances.
  • Personal loans. With a personal loan used for debt consolidation, you take out a new loan from a bank, credit union, or other lender to pay off higher-interest debt, such as debt credit card or other bills.
  • Balance transfer credit card. If you have sufficient credit, you can transfer balances from multiple credit cards to a new balance transfer credit card at a lower interest rate, sometimes 0% APR for an introductory period.
  • Home equity loan. If you own your home and have built up enough equity to qualify, you may be able to use a home equity loan or a home equity line of credit (HELOC) to consolidate your debt at an affordable rate. lower interest.
  • Cash mortgage refinance. A mortgage refinance with drawdown gives you the option of refinancing your home for more than the outstanding balance. You can use the cash difference to pay off outstanding debts.

Alternatives to debt consolidation

If you don’t want to take out a new loan, open a credit card, or dip into your home equity to consolidate your debt, there are several other alternatives:

  • Pay off your debts on your own. If your debt payments are manageable, you can make a plan to pay off the debt faster. If you have enough income and room to maneuver in your monthly budget, you may be able to pay off your debts quickly without debt consolidation, using the snowball or debt avalanche method.
  • Enter a debt management program (DMP). If you’re having trouble paying your bills, you can work with a nonprofit consumer credit counseling agency to set up a debt management program where you agree to pay off your debts with a monthly payment. to the credit counseling agency, which then pays your creditors for you.
  • File the balance sheet. If you’re having trouble paying your bills, don’t want (or can’t get permission) to borrow more money, and don’t think you’ll be able to pay off your debts, you might want to be considering declaring bankruptcy. This legal process can erase some or all of your debts and help you get a fresh start. But be aware that bankruptcy stays on your credit report for seven to 10 years.
  • Consider debt settlement, but as a last resort. If you’ve fallen behind on your debts, you might consider negotiating with your creditors to accept less money than you owe. This is called debt settlement, and you can do it yourself or by working with a debt settlement company. But be careful. Debt settlement can be risky. Creditors are not required to accept your debt settlement offer and may not want to negotiate. And the debt settlement process usually causes significant damage to your credit. It should only be considered as a last resort.


Is Debt Consolidation Harming Your Credit? It depends. If you’re using debt consolidation as a strategy to get out of debt, you may need to be prepared for a short-term drop in your credit score. But when you can manage your payments responsibly and start making progress in paying off your debts, debt consolidation can help you get better credit and a stronger financial future.

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