Does Debt Consolidation Hurt Credit?
Everyone who has debt wants to be free of it. Luckily there are plenty of responsible avenues available that can help you manage and even get rid of your debt.
Debt consolidation is one such method and involves combining all debts into one. This is a popular choice because it means only having to manage one payment rather juggling multiple payments from various lenders. It also typically comes with a lower interest rate so you’re paying less in the long run.
While there are plenty of reasons why and how debt consolidation can help you inch closer to financial freedom, does it come at a price? Many people exploring this option have a viable concern: does debt consolidation hurt my credit? There is no quick answer, how debt consolidation will impact your score depends on how you go about it.
In this article, we’re going to review how debt consolidation can hurt your credit and how it can help.
How Debt Consolidation Helps Credit
One of the advantages of debt consolidation is that it can help give your credit score a boost in a few ways:
Making your monthly payments on your debt consolidation loan on time, every time is key. Ever wonder how your FICO credit score is calculated? While factors like length of credit history and credit mix have their role in influencing your credit score, the most important factor is payment history—how often are you late on your payments, how often are you on time with your payments, this information is all used in calculating your score.
By consolidating your debt, you’ve reduced your monthly payments to just one, making it far easier to stay on top of your debt and making payments on time which will positively impact your credit score.
A Bigger, Better Loan History
You can also see an increase in your score by consolidating your debt with an installment loan, such as a personal loan.
When taking out a debt consolidation loan to pay off credit cards that have or are close to reaching their credit limit, this will bring down your credit utilization ratio on revolving debt. This can give a boost to your credit score if you don’t run up the balance again right away and if you don’t close the accounts. According to Experian, closing a credit card account even when it’s paid off can lead to an increase in your overall credit utilization rate, which can have a negative effect on your score. So don’t do it!
If you’ve only held one type of credit account in your credit history, adding a personal loan into the mix can help your score. It shows lenders that you’re more financially responsible.
Healthy Finances, Healthy Credit
Hopefully, through the process of debt consolidation, you are able to address how you have managed your finances in the past and how you plan on moving forward so you have a better shot at smartly managing your debt and keeping it down.
How Debt Consolidation Hurts Credit
While consolidating debt certainly has its advantages, it does not always result in an improved credit score. On the contrary, sometimes debt consolidation can hurt your credit. Let’s take a look at how this can happen:
Running up Balances
After consolidating your debt, you can hurt your score if you start running up your balances again on your credit cards. Any gains you may have seen from lowering your credit utilization will quickly dissipate as soon as there are rising balances.
If you’re using a balance transfer to move all of your credit card debt to another single card but have maxed out your credit limit, this will bring up your utilization ratio. Even though you’ve consolidated your debt, being maxed out or even close to maxed out is a big red flag for creditors and can hurt your score.
Closing Credit Card Accounts
As mentioned earlier, closing out your credit card accounts after paying them off through debt consolidation is a big no-no. While it may feel great to eliminate these accounts from your life after successfully paying them down, don’t do it. This will cut into the overall length of credit history you had with that account and will bring up your credit utilization.
Just like making payments on time can help your credit score, making payments on your consolidated debt loan 30 days or more late can hurt it. Now that you only have one payment to worry about, stay on top of it to ensure your account does not fall delinquent.
Keep in mind that every debt consolidation application you make, whether you’re trying to get a personal loan or balance-transfer card, will knock a few points off of your score. So consider which ones you’re most likely to qualify for and just apply to those. Too many applications at once can look like financial instability to creditors.
So, does debt consolidation hurt credit?
Such as most things in life, there is no one-size-fits-all solution on how consolidating debt will affect your score, but there are some pragmatic considerations you can use to see how it can affect you. The general rule of thumb is, if used properly, debt consolidation can be the right path for regaining financial well-being and even a great way to give your credit score a boost.
* Please consult with your attorney, financial consultant/planner, accountant, and/or tax advisor for advice concerning your particular circumstances. The information contained herein is for general informational and educational purposes only and should not be construed as professional, tax, financial or legal advice or a legal opinion on specific facts or circumstances. The information or opinions contained herein should not be construed by any consumer and/or prospective client as an offer to sell or the solicitation of an offer to buy any particular product or service.