Looking for streamlined finances, simplified monthly bills, and a better credit score? Aren’t we all! Debt consolidation can help, but it’s not a magic fix. You’ll have to stay on track with your debt consolidation plan and know all the ways debt consolidation can help, or hurt your credit score. To get started, what is debt consolidation?
What is debt consolidation?
Debt consolidation is the process of combining multiple debts and payments into a single debt with a single monthly payment. Consolidating your debt can help you simplify your monthly finances by reducing the number of bills you have to manage. It can also help you save money by lowering your interest rate, your monthly payment, or both. Debt consolidation can also help you make real progress on paying down debt. All good things!
The two primary ways to consolidate debt are balance transfer cards and debt consolidation loans.
- With a balance transfer credit card, people transfer their debt to a low-rate balance transfer card. This can be a good strategy for saving on interest in the short term, but the rate typically rises after a short introductory period and may change on an ongoing basis.
- With debt consolidation loans, people get a personal loan and use it to pay off multiple debts with multiple payments. Most debt consolidation loans have fixed rates and terms, so this can be a good strategy for getting a more predictable monthly payment and having a clear payoff date.
Learn more about how debt consolidation loans work.
Will debt consolidation hurt my credit score?
Your credit score depends on a variety of factors that all work together to affect your score. Consolidating your debt can impact many of those factors, potentially boosting your score in the process. Keep in mind, debt consolidation alone does not automatically improve your score. Your credit score really depends on how you behave after you consolidate your debt. Will you stay on top of your monthly payments? Will you avoid running up balances again? Will you open even more new accounts?
The impact to your credit score also depends on which method you use to consolidate your debt. In this article, we’ll focus on how debt consolidation loans can impact your credit score.
Ways a debt consolidation loan may help your credit score
Credit Utilization Ratio
Your credit utilization ratio measures how much of your total available credit you are using. Using a personal loan to pay off existing credit card debt will improve your credit utilization ratio, which may improve your score. Keep in mind: you’ll have to avoid running up your credit card balances again or you’ll be back where you started, or worse.
Credit Mix
Credit mix is the different types of credit accounts you have -- particularly how much revolving debt vs. installment debt you have. More variety in the types of credit you have can generally help your score. If you use a debt consolidation loan to replace some credit card debt, you’re adding an installment account to your credit profile, which will diversify your credit mix and potentially boost your score.
Payment History
The biggest factor impacting your credit score is your payment history -- even one late payment can hurt your credit score. If the streamlined monthly payments that come with debt consolidation will help you pay on time, every time, then debt consolidation can boost your credit score by helping you avoid late payments.
Ways a debt consolidation loan may hurt your credit score
Credit Inquiries
When you open a new account, such as a debt consolidation loan, the lender will typically perform a hard inquiry on your record at the credit bureau. A single inquiry will most likely not have a huge impact on your credit score, but it may cause a small dip for a few months. It’s always a good idea to shop around for the best rate, but make sure you know how to protect your credit when applying for credit.
Average age of credit
Establishing a long credit history usually helps your credit score, providing you have a history of on-time payments on your open accounts. When you take out a new debt consolidation loan, your average age of credit accounts will decrease, which may cause a dip in your credit. You can mitigate this by keeping your oldest credit card accounts open (as long as you aren’t paying high fees or find that you’re racking up too much debt).
How to get the most out of your debt consolidation loan
To get the biggest benefit from your debt consolidation loan—both for your wallet and your credit score--it’s important to stay on track. Use the loan as you intended and pay off your high-interest debt. There are a variety of techniques that may help you pay off debt quickly.
Once you’ve consolidated your debt, resist the temptation to run up balances again. It’s a good idea to revisit your budget on a regular basis to keep spending in check. With streamlined payments, make sure you stay on top of your monthly payments. More tips on how to stay on track with your debt consolidation loan.
Get Started
Now that you know the ins and outs of how debt consolidation may impact your credit score and how to stay on track, it’s easy to get started. As a first step, check your rate for a debt consolidation loan and see what you qualify for.
