Can Debt Consolidation Damage My Credit?

When you consolidate your debt, you take out a new loan to pay off multiple existing debts. This simplifies your repayment process and ideally saves on interest. And there is truth to the statement that consolidating your debt can have an initial negative impact on your credit.

This is because any new loan usually requires a hard credit inquiry to qualify. According to Experian, hard inquiries can lower your credit score by about five points. However, as long as you keep up with your payments, this only lasts for a few months.

In the long run, debt consolidation can boost your credit score significantly if done correctly. Here’s how it works.

How does debt consolidation work?

Debt consolidation involves taking out a new loan to pay off multiple credit accounts, including credit cards, lines of credit, or other high-interest loans. There are three potential benefits—you can reduce your monthly payments (simplifying your debt payoff), ideally lower your interest costs, and close troublesome revolving credit accounts that are so difficult to pay down.

Ways to consolidate your debt

The two most common ways to consolidate debt are to take out an unsecured personal loan or execute a credit card balance transfer.

Personal loan

To consolidate debt with a personal loan, you’d choose a loan large enough to cover all your existing debts—credit cards, student loans, or whatever else you might have—and pay them all off from the loan proceeds. You’d then repay the personal loan in regular monthly installments. (Bonus points for paying it off before the term ends, providing there are no early repayment penalties.)

Credit card balance transfer

To consolidate debt with a credit card balance transfer, you’d look for a credit card that accepts balance transfers. These usually offer a 0% introductory interest rate for a specific promotional period, often between 12 and 21 months. You’d then transfer your other credit card debts (and any additional debts, if the balance transfer card issuer allows) onto the new card. Your goal should be fully paying the card balance before the promotional period ends.

That last part is very important: If you go beyond the promotional period, the regular annual percentage rate (APR) will set in—not only on any new purchases you make with the card but also on any remaining balance from the transfer.

For this reason, a credit card balance transfer is best left to those who already have fairly good credit—you’ll need it to successfully apply for the card—and who are confident they’ll be able to repay the debt in full on time.

Pros of debt consolidation

There are plenty of good reasons to consider debt consolidation as part of your debt repayment strategy, including the following:

• It could save you money. If you take out a personal loan at a low interest rate or secure a 0% APR balance transfer card, you could save hundreds, if not thousands, of dollars on the interest you’d otherwise be paying for.
• It can help improve your credit. If you can use debt consolidation to lower your overall total debt balance—a factor that makes up 30% of your credit score, according to Experian—you may improve your credit score significantly over time.
• You might pay down debt faster. With the motivation of a promotional interest period or the regularity of monthly installments of a personal loan, you can climb out of debt faster by consolidating.
• It can make your life easier. It’s much easier to keep up with one monthly debt payment than five or six. Debt consolidation can be seen as an organizational tool as much as a financial tactic.

Cons of debt consolidation

There are also some potential drawbacks to debt consolidation. Some people might want to take a different approach. For example:

• You need decent credit to qualify. To successfully apply for a new loan or credit card, you’ll need a good credit score—especially if you want to qualify for the lowest interest rates. If your credit is poor, debt consolidation may not be possible.
• Up-front fees may apply. Many credit card balance transfers and personal loans come with upfront origination or transfer fees, which can eat into your interest savings. (The math may work out in your favor, but running the numbers is important).
• If you continue to spend on credit, your situation could get worse. The last thing you want to do is take out a new loan or credit card to get out of debt, only to continue to overspend and allow the debt cycle to persist. If you do, your credit score would almost certainly worsen, and your financial situation could become even harder to handle.

How debt consolidation can affect your credit

As mentioned, applying for a new loan can temporarily reduce your credit score by a few points. However, debt consolidation can help you improve your credit if you can reduce your overall balance over time. Remember, you must be diligent about making timely monthly payments, and avoid building up new debt.

How do you decide when debt consolidation is a good idea?

Ultimately, you’re the person who knows your financial situation best—aside from perhaps your financial advisor or spouse.

Here are some signs that debt consolidation might be the right move:

• You have a decent, if not excellent, credit score. This will make qualifying for the new credit you’ll need to consolidate debt easier—ideally at a lower interest rate than you’re already paying.
• You have stable employment and consistent income. Earning enough to pay off the new loan is critical to avoid further debt.
• You budget regularly. A budget can ensure you have enough money to pay for the new loan and avoid going into further debt to make ends meet.
• You feel overwhelmed by the number of payments you deal with each month. One of the best reasons to consolidate debt is to get organized. Even a single late payment can substantially impact your credit score, so simplifying your debt payoff can help.

Debt consolidation alternatives

While debt consolidation can be a powerful tool, it’s not the only one at your disposal. If you’re weighed down by debt, you can also consider:

The debt snowball method

The debt snowball method involves paying your lowest-balance debt first and then laddering up, slowly paying off debts through their highest balance. As you do this, you will maintain the minimum payments on your other debts so they remain in good standing. You might pay more interest in the long run compared to if you paid off the highest APR debts first, but the benefit is psychological. The faster you can get quick wins, the more motivated you’ll be to keep going.

Debt counseling

Even if debt consolidation does work for you, it probably won’t help for long if you don’t fix the reasons you got into debt in the first place. A debt counselor can help you create a debt management plan and get the intel you need to avoid going into debt again.

Filing for bankruptcy

While certainly the nuclear option and one that can wreak havoc on your credit score, if you’re truly in dire financial straits, filing for bankruptcy can sometimes be a boon in the long run. It should be considered a last resort; bankruptcies will persist for seven or 10 years on your credit report, depending on which type you file for.

Debt settlement

You can attempt debt settlement (aka debt resolution or debt relief) by negotiating directly with your creditors for more favorable repayment terms. This includes trying to get them to accept less than you owe. You can also pay a company to do this, but never work with any company that asks for fees upfront. Reputable firms accept payment only once the debt has been settled.

TIME Stamp: Debt consolidation can help, but it’s not your only option

While debt consolidation may temporarily impact your credit, it can help you pay down your debt more quickly. However, you can also DIY your debt repayment plan using free strategies such as the snowball method.

Frequently asked questions (FAQs)

Does debt consolidation mess with your credit score?

It can—but if done correctly, it should only be a problem in the short term. When you apply for a new line of credit or loan to consolidate your debt, your score might take a hit of a few points, but the impact should be minimal and brief.

Remember that if you fall behind on your loan payments or continue adding to your debt, your score may drop significantly. So, if you’re going to try debt consolidation, be sure you can make ends meet without putting more money on your credit cards.

What is a disadvantage of debt consolidation?

One disadvantage of debt consolidation is that it favors people with good credit scores. For example, you’ll usually need a score of 670 or higher to be approved for a balance transfer credit card, and unsecured personal loans tend to have more stringent eligibility requirements than secured loans. Plus, the higher your score, the more likely you are to receive a lower interest rate—which is one of the ways debt consolidation can help you save money.

Is it a good idea to consolidate debt?

Like any financial choice, whether or not debt consolidation is right for you depends on your specific circumstances and goals. If you’re overwhelmed by multiple payments and losing money to high interest rates, debt consolidation may help. But if you cannot pay the new debt or continue to add to your debt, it may not help your situation.

How long does a debt consolidation stay on your credit?

Debt consolidation doesn’t show up on your credit report, per se; the loan or line of credit you take out to perform the consolidation will, though. That loan or credit card will show up on your report for as long as it’s active and open—or, if you fall behind and it goes to collections, up to seven years.