How Does Debt Consolidation Affect Your Credit?
Summary
Discover how debt consolidation can affect your credit score. Learn if taking out a loan can hurt or help your credit.
In this article:
Debt consolidation is a financial strategy that allows you to combine multiple debts — including credit cards and personal loans — into one. Taking out a debt consolidation loan to pay off several debts may offer you lower monthly payments, a lower interest rate, simpler loan terms and a set payoff date.
Debt consolidation loans may have various effects on your credit score, so make sure you understand how these loans work before you apply.
Does debt consolidation hurt your credit?
Debt consolidation may influence your credit score positively or negatively, depending on your situation and financial habits.
Let’s look closer into the ways consolidating debt might affect your credit.
How can debt consolidation hurt your credit?
Overall, managing your debt consolidation loan responsibly by making timely payments and reducing your overall debt can have a positive impact on your credit score over time. But there are a few potential negative effects to keep in mind:
Triggers a hard inquiry: When you apply for a debt consolidation loan, it triggers a hard credit check, which has a small, temporary impact on your credit score. To avoid multiple hard inquiries, see if you prequalify before you apply. Prequalifying takes only a few minutes and doesn’t affect your credit score. It can also give you an idea of your approval chances before submitting a formal application.
May not improve your credit utilization ratio: If you continue to use your credit cards after paying off your credit card debt, a debt consolidation loan may not benefit your credit utilization ratio.
Decreases the average age of your accounts: A new debt consolidation loan may lower your credit score slightly by bringing down the average age of your credit accounts.
Doesn’t guarantee a stronger payment history: Debt consolidation may make your debt payments more manageable by having a single loan payment each month. However, you must make payments on time, every time, for your credit score to gradually increase.
Does debt consolidation help your credit?
If you’re consistently making loan payments on time, a debt consolidation loan could have a positive long-term impact on your credit.
How can debt consolidation help your credit?
There are several advantages to consolidating your debts:
May improve credit mix: Having a mix of revolving credit, like credit cards, and installment credit, like personal loans, may boost your credit score and show lenders you can manage multiple types of debts. If most of your existing debts are credit cards or lines of credit, a debt consolidation loan may improve your credit mix.
May support a consistent payment history: Consolidating multiple balances into one loan with a single, predictable monthly payment may make it easier to pay on time each month. Consistent payment history is crucial for establishing a strong credit score.
Might make debt easier to pay off: In some cases, a debt consolidation loan may save you money in interest charges, especially if you’re consolidating multiple high-interest accounts. With lower interest, you may be able to pay off your debts more quickly, which may have a positive impact on your credit score.
May decrease your credit utilization ratio: Credit utilization is the total percentage of revolving credit in use at one time compared to your total available credit, and it accounts for 30% of your credit score. If you keep a zero or low balance on your credit cards after paying them off with a debt consolidation loan, your credit utilization may go down. Over time, this may boost your credit score.
How long does a debt consolidation loan affect your credit?
If a debt consolidation loan makes it easier to manage your debt, it may help you avoid long-lasting negative marks on your credit score. And if you’ve paid on time and closed the account in good standing, that positive record lasts for 10 years.2 However, any negative information associated with a debt consolidation loan, like late or missed payments, could stay on your credit report for seven years.
What are other options for debt consolidation?
Debt consolidation loans aren’t the only way to pay off multiple debts. Below are a few alternatives to consider. Keep in mind that each comes with its own set of benefits and drawbacks. The right choice for you depends on your individual financial situation.
Credit card balance transfer: Moving your high-interest credit card balances onto a single card may be beneficial if you are offered a lower interest rate. But keep in mind that many cards offer low promotional rates that only last for a specific period. After that, a higher rate kicks in and will be applied to the balance you haven’t paid off.
Home equity loan or line of credit: You could use the equity in your home as collateral to get a loan or line of credit. Home equity is the difference between what you owe on your mortgage and the current value of your home. Collateral is something of value you possess. If you can’t make payments, the lender has the right to foreclose on your home.
401(k) loan: Some employer-sponsored retirement plans allow you to borrow money from your account. A 401(k) loan could be a convenient debt consolidation option, but know there are risks involved, like penalties and taxes if you’re unable to repay the loan on time or you’re not yet eligible.
Friend or family loan: If you decide to borrow from friends and family, be sure to set clear repayment terms so the financial relationship doesn’t harm your personal relationship.
Make debt consolidation work in your favor
Ultimately, the key to making debt consolidation work for you is to approach it responsibly. Be sure to carefully evaluate your options, choose the right strategy for your financial situation, and commit to disciplined repayment. Consistent on-time repayment helps establish good financial habits over time, so you can keep making progress toward your financial goals.
This article has been updated from previous postings in 2020 and 2024. Melina Duffett and Kia Jackson contributed.
Sources
This article is for general education and informational purposes, without any express or implied warranty of any kind, including warranties of accuracy, completeness, or fitness for any purpose and is not intended to be and does not constitute financial, legal, tax, or any other advice. Parties (other than sponsored partners of OneMain Financial (OMF)) referenced in the article are not sponsors of, do not endorse, and are not otherwise affiliated with OMF.
