Does Debt Consolidation Hurt Your Credit? (2024)

If you’re having trouble paying bills or want to get out of debt faster, debt consolidation could be a solution. But before you move forward with this debt relief method, it’s important to understand what it does to your credit, how the process works and what your other options are.

How Does Debt Consolidation Work?

Debt consolidation is a form of debt relief that typically involves taking out a new loan to pay off previous loans, combining the debts—consolidating them—into a single monthly payment. Debt consolidation can offer several benefits, such as lowering your interest rate, simplifying your monthly payments and getting out of debt faster.

If you’re trying to decide whether debt consolidation is a good idea, start by looking at your overall financial life. Debt consolidation could be a fit if you have trouble paying your bills, are not comfortable with your current amount of debt or are unsatisfied with the interest rates (APRs) on your existing credit cards or loans.

However, it’s also important to be aware of how debt consolidation could cause changes to your credit score. Take care to manage your credit score while paying off debt.

How Debt Consolidation Affects Your Credit

Debt consolidation could have an impact on your credit score, both good and bad. Below are five ways debt consolidation could affect your credit score positively or negatively.

1. It Could Cause Hard Inquiries on Your Credit

Every time you formally apply for credit, the creditor makes a hard inquiry, also known as pulling your credit, to check your creditworthiness. Each hard inquiry generally reduces your credit score by a few points. If you are shopping around and applying for debt consolidation loans at multiple banks at once, your credit could take a temporary hit. Fortunately, numerous hard inquiries within a set period, anywhere from 14 to 45 days, are typically combined into one when your credit score is calculated.

Remember that a hard inquiry isn’t necessary every time you talk to a lender or visit a website. It’s possible to do your research and get prequalified for a loan without having to go through the hard inquiry process. Many lenders will let you shop for rates and prequalify online by doing a soft credit check, or soft pull, that does not affect your credit score. This enables you to take the first steps to see if you qualify for a loan, but without dinging your credit.

Before deciding to move forward with a lender, read the fine print and make sure you understand whether or not you are ready for your credit to get checked with a hard inquiry as part of the loan application process.

2. Your Credit Utilization May Change

Creditors and credit rating agencies pay attention to your credit utilization ratio, which makes up about 30% of your FICO credit score. Your credit utilization ratio is the percentage of available credit that you’re using at any time. For example, if you have a credit card with a credit limit of $15,000 and a balance of $4,500, your credit utilization ratio would be 30%.

If your credit utilization ratio moves higher after debt consolidation, it could negatively impact your credit score. Using the example above, if you transfer the balance of $4,500 from your existing credit card with a limit of $15,000 to a new credit card with a credit limit of $7,500, your credit utilization ratio on that new card will be 60%, potentially causing a hit to your credit score.

On the other hand, if you consolidate multiple credit card debts into one new personal loan, your credit utilization ratio and credit score could improve. Credit cards and personal loans are considered two separate types of debt when assessing your credit mix, which accounts for 10% of your FICO credit score.

For example, let’s say you have three credit cards. Once again, using the example above:

• The first card has a $4,500 balance with a $15,000 credit limit.
• The second card has a $2,000 balance with a $10,000 credit limit.
• The third card has a $5,000 balance with a $10,000 credit limit.

You would have credit utilization ratios of 30%, 20% and 50%, respectively, for these three cards. (Combining the cards, your overall credit utilization is nearly 33%.) If you combine all three of those debts into one new personal loan of $11,500, the credit utilization ratios for each of those three cards will drop to zero (provided you keep the credit card accounts open and you don’t do additional spending on the cards), which could improve your credit score.

3. The Average Age of Your Accounts Could Decline

Another factor in determining your credit score is the average age of your accounts, or how long you have had those accounts open. This shows your overall length of credit history and makes up about 15% of your FICO credit score.

If you open up a new credit account as part of your debt consolidation plan, whether that’s a new balance transfer credit card or a new personal loan, the average age of accounts will decline and you may see a drop in your credit score. But depending on how many other credit accounts you have and your overall credit history, the decline may not be significant.

4. It May Improve Your Payment History Long Term

Payment history makes up about 35% of your credit score. If you already have a solid track record of making on-time payments, debt consolidation may not affect this aspect of your credit score. But if consolidating your debts into a new loan at a lower interest rate will make it easier for you to make payments on time, then debt consolidation could help improve your credit score in the long run.

5. It Could Tempt You to Close Accounts

If you’re going through the debt consolidation process, it could feel good to close your old accounts after a balance transfer or getting a new loan. But be careful. Closing a credit account could decrease your average age of accounts or drive up your credit utilization ratio. Both of these actions can hurt your credit score.

After you complete your debt consolidation process, consider leaving your old credit accounts open but with zero balances. Keeping those accounts open and on your credit report can be good for your credit score, so long as you’re not tempted to use them to rack up more debt.

How To Consolidate Debt

There are several different ways to consolidate debt:

• Debt consolidation loans. Debt consolidation loans are a type of personal loan available through banks, credit unions and online lenders. With this type of loan, lenders may pay off your debt directly or provide the cash for the borrower to pay off their outstanding balances.
• Personal loans. With a personal loan used for debt consolidation, you take out a new loan from a bank, credit union or another lender to pay off higher-interest debts, such as credit card debts or other bills.
• Balance transfer credit card. If you have good enough credit, you can transfer the balance of several credit cards to a new balance transfer credit card at a lower interest rate, sometimes at 0% APR for an introductory period.
• Home equity loan. If you own your home and have built up enough equity to qualify, you may be able to use a home equity loan or home equity line of credit (HELOC) to consolidate your debt at a lower interest rate.
• Cash-out mortgage refinance. A cash-out mortgage refinance gives you the option to refinance your home for more than the outstanding balance. You can use the difference in cash to pay off outstanding debts.

How To Consolidate Credit Card Debt Without Hurting Your Credit

Fortunately, there are ways to minimize the negative impact that debt consolidation can have on your credit.

• Pay your bills on time. Missing a payment is one of the fastest ways to harm your credit and takes the longest to recover from. Once you consolidate your debt, enroll in autopay so you never forget to pay your bill. If you’re struggling to make payments, create a budget to help manage your spending or consider the alternatives below.
• Limit hard inquiries. Hard inquiries on your credit report may impact your credit score, which is why limiting applications for new credit is crucial. Always look at the suggested credit score to ensure your credit is within the range, and only apply for cards and loans with good approval odds to avoid unnecessary inquiries.

Alternatives to Debt Consolidation

If you don’t want to take out a new loan, open a credit card or tap your home equity to consolidate debt, there are aseveral other alternatives:

• Pay off debts on your own. If your debt payments are manageable, you can make a plan to pay off debt faster. If you have sufficient income and room in your monthly budget, you may be able to pay off your debts fast without debt consolidation, using the debt snowball or debt avalanche method.
• Enter into a debt management program (DMP). If you are having trouble paying your bills, you can work with a nonprofit consumer credit counseling agency to set up a debt management program where you agree to pay off your debts with one monthly payment to the credit counseling agency, which then pays your creditors for you.
• File for bankruptcy. If you’re struggling to pay your bills, you don’t want (or cannot get approved) to borrow any more money and you don’t believe you will be able to repay your debts, you may want to consider declaring bankruptcy. This legal process can wipe out some or all of your debts and help you make a fresh start. But be aware that bankruptcy stays on your credit report for seven to 10 years.
• Consider debt settlement, but as a last resort. If you have fallen behind on your debts, you may consider negotiating with your creditors to accept a smaller amount of money than what you owe. This is called debt settlement, and you can do it yourself or by working with a debt settlement company. But be cautious. Debt settlement can be risky. Creditors are not required to accept your debt settlement offer and may not want to negotiate. And the debt settlement process typically causes significant damage to your credit. It should be considered only as a last resort.

Bottom Line

If you’re overwhelmed by debt, the benefits of consolidation may be worth a temporary hit to your credit score. Debt consolidation is a way to simplify your debt and give yourself some breathing room to focus on other financial and life goals.

Frequently Asked Questions (FAQs)