If you’re juggling multiple credit cards and other loans every month, debt consolidation could offer the relief you’re after. By rolling your high-interest debt into a single monthly payment with a lower rate, you can save money while getting out of debt faster. But if you’re hesitating due to a potential score impact, here’s a detailed explanation of how it can help your credit score in the long term.
How debt consolidation affects your credit
Debt consolidation involves applying for a new debt consolidation loan or balance transfer credit card so that you can combine your debts into a single payment every month. While opening a new account for debt consolidation can temporarily lower your credit score, these negative effects should lift as you make on-time payments. Here’s a look at the negative vs. positive impacts.
| Negative impacts | Positive impacts |
|---|---|
| Hard inquiry. When you apply for new credit, a hard inquiry is run on your credit report, which can lower your credit score up to 10 points for up to one year, although it might just be a few points. | Improved credit utilization. By consolidating debt and consistently paying it down, you can lower your credit utilization. |
| New account. Opening a new account, such as a balance transfer credit card or a personal loan, reduces the average age of all your accounts which can decrease your score. | Credit mix. If you use a personal loan for debt consolidation, it can improve your credit mix, which makes up 10% of your credit score. |
| Closing credit accounts. While closing a credit account after consolidating it, can increase your credit utilization ratio, it will decrease the average age of your accounts at the same time, which can drop your score. | Credit score increases. As long as you make on-time payments toward your debt consolidation loan and don’t take on new unsecured debt, your creditworthiness should improve over time. |
How long will it take for my score to improve after debt consolidation?
While there are no guarantees, according to Experian, you should see an improvement in your credit score as soon as one or two months after you pay off a debt. For example, if you pay off a credit card, you should see your credit score rise after 30 to 45 days, and for installment loans, you should see an increase after one or two months.
How debt consolidation works
Debt consolidation involves combining multiple debts into a lower-interest personal loan or a 0% APR balance transfer credit card. When you apply for a new debt consolidation loan, you can often arrange to have the company pay your creditors directly in exchange for a discounted rate.
While opening a new account for debt consolidation can temporarily lower your credit score, these negative effects should lift as you make on-time payments. And, as your overall debt decreases, you should see your score improve significantly over time. Learn more about how debt consolidation works.
Consolidating with a personal loan
If you’re considering taking out a personal loan to consolidate debt, here are the main pros and cons to be aware of:
Pros
- Lower interest rate. You may be able to secure a lower interest rate with a personal loan than what’s on your credit cards, especially if you have good credit.
- Simplified payment. Combining multiple debts into a single loan reduces the number of monthly payments, making it easier to manage your finances.
- Faster debt repayment. You may pay less in interest, helping you get out of debt faster.
- Improved credit score. Consolidating debt can boost your credit score with an on-time payment history, and can help with your revolving credit utilization ratio if you consolidate credit cards. These two factors alone account for 65% of your total credit score.
- Clear payoff date. Using personal loans to payoff debt can mean a clear end date to the payments, motivating finish line to being debt-free.
Cons
- Paying more over time. If you choose to spread out your loan payments over a long period, this could result in higher interest costs.
- Origination fees. Some lenders charge origination fees on debt consolidation loans, especially if you have bad to fair credit.
- Risking assets. If you consolidate debt with a secured loan, you risk losing your assets if you can’t make the payments.
- Adding more debt. When consolidating debt, it’s still possible to rack up more debt and compound the original problem.
- Credit score impact. Applying for a new loan temporarily lowers your credit score, as well as closing any existing accounts.
Explore some of the best debt consolidation loans for low interest rates and budget-friendly repayment options.
Consolidating with a balance transfer card
If you have good credit and can get a 0% introductory rate credit card, here are the main pros and cons to weigh:
Pros
- Lower interest rate. Many balance transfer cards provide a 0% introductory APR on transferred balances, allowing you to defer paying interest for several months.
- Faster debt repayment. With a 0% introductory APR, you can put more of your money towards your principal balance and pay it down faster.
- Fewer monthly bills. Consolidating debt onto a single credit card can reduce the number of payments you have to juggle each month.
- Flexibility. Balance transfer cards typically offer a 6 to 21 month 0% introductory period, giving you time to pay down your debt.
- Rewards. While you won’t earn rewards on transferred balances, many cards let you earn rewards on purchases during the introductory period.
Cons
- Eligibility requirements. Not everyone will qualify for a 0% balance transfer card, especially if you have a poor credit history.
- Balance transfer fees. Balance transfer cards typically charge a fee for transferring a balance, which can add to the cost of your debt repayment.
- Potential for increased debt. Without discipline and a repayment plan, a balance transfer can easily lead to accruing more debt.
- Credit score impact. Applying for a new credit card and doing a balance transfer can lead to a temporary decrease in your credit score.
- Limited promotional period. Unlike a personal loan that has a constant fixed rate, the introductory offer on a balance transfer card will expire.
Compare the best balance transfer cards for 0% intro APRs and generous promotional periods.
Is debt consolidation a good idea if you have bad credit?
It depends. While it’s possible to qualify for a debt consolidation loan with bad credit, it may or may not be worth it. Currently, the average rate for personal loans for those with bad to fair credit is between 17.80% and 32.00% – which may not be much better than what you’re already paying on your credit cards. You’ll also likely be on the hook for an origination fee of 1% to 10%, which further adds to the cost of borrowing.
However, if you can get a lower rate by using a creditworthy cosigner or with a secured loan, it could be a good move. And debt consolidation may improve your credit score over time, as long as you keep up with your payments and don’t take on new credit.
But if you have poor credit and a high amount of debt, it’s a good idea to weigh the pros and cons first and consider alternative debt payoff strategies, like credit counseling, the debt avalanche or debt snowball methods, or even debt relief.
What if I have good credit?
If you have good to excellent credit, debt consolidation can definitely be a smart idea, especially if you can snag a good rate. Right now, the average interest rate on personal loans for good credit borrowers is between 10.73% to 12.50%, much lower than the average credit card rate of 20.92%.
This means a good credit borrower could potentially shave 10% off their interest obligations with a competitively priced debt consolidation loan. Also, borrowers with good credit can generally qualify for 0% APR balance transfer credit cards. These can be even cheaper than a loan if you pay off your debt during the promotional period.
While your credit score may temporarily dip as you open a new account for debt consolidation, you should see this number improve as you pay off your unsecured debts entirely.
7 ways to make debt consolidation work
Because debt consolidation involves taking on more debt, here are seven strategies to help make it work for you:
- Research your options. Research and compare secured or unsecured personal loans, 0% APR balance transfer cards, debt management strategies, or even debt settlement.
- Choose wisely. Only apply for loans or credit cards that you know you’re qualified for. Doing this helps you avoid multiple hard credit pulls on your credit file.
- Pay more towards your loan. If your situation allows for it, pay more than the required minimum on your debt consolidated loan.
- Look for discounts. Many personal loan lenders offer discounts for paying your creditors directly, setting up autopay, using a cosigner or securing the loan with assets, like a car.
- Apply with a cosigner. Having a relative with good credit back your loan makes you less of a risk to lenders and could get you a better deal.
- Get a secured loan. Get more favorable terms on your debt consolidation loan by putting up collateral, like a car. But this option comes with risk.
- Review your spending habits. Review your budget and consider adjusting spending habits to avoid falling back into debt.
Debt consolidation alternatives
If you don’t qualify for a debt consolidation loan or balance transfer card or would rather not take on more unsecured debt, consider these alternatives:
- Credit counseling. Contact a counseling agency and set up a free meeting to explore your alternatives and come up with strategies for paying off your debt.
- Debt management. Have a credit counseling agency negotiate with your creditors to reduce your interest rate and monthly payments and set you up with a debt management plan.
- Debt settlement. Sign up to have a debt relief company negotiate down your balance for a debt settlement or work with your creditors directly to lower your balances.
- Home equity products. If you own a home with at least 20% equity, you could take on a home equity loan or home equity line of credit (HELOC) to consolidate your debt. But you risk losing your home if you can’t keep up with the payments.
- Bankruptcy. Best saved as a last resort, you can file for Chapter 11 or 13 bankruptcy to have a judge either eliminate or reduce the amount you owe to your creditors.
Bottom line
Debt consolidation can be a good option for those with good credit who can secure a low interest debt consolidation loan or 0% APR balance transfer credit card. But it may not work if you have bad credit, since you may not be able to get a competitive rate.
If poor credit and large debts are holding you back, you can also look into a debt relief program, but be aware these programs can impact your credit score much more than debt consolidation.
