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How Will Debt Consolidation Affect My Credit?

Written by: Kristy Welsh

Last Updated: July 19, 2017

Ideally, debt consolidation lowers your interest rate and monthly payments, but there’s no guarantee of that; it all depends on the terms of your new loan. The same is true of the impact debt consolidation has on your credit. Under some circumstances it can be good, under others not so much. Find out what you can do to maximize the benefit to your credit score, as well as what’s beyond your control.

Hard Credit Inquiry

The fewer hard inquiries you have on your credit reports, the better.

Every time you apply for a new line of credit, it counts as a hard inquiry, which puts a dent in your credit score. A debt consolidation loan is no exception, whether you’re applying for a new credit card to do a balance transfer or for an installment loan (i.e., personal loan, home equity line of credit).

Fortunately, a hard inquiry shouldn’t hurt your credit more than 5 points. And though it stays on your credit reports up to 2 years, it stops affecting your credit score after 12 months.

Credit Utilization Ratio

The less available credit you’re using, the better.

Amounts owed affects 30 percent of your FICO score. That said, credit utilization ratio only factors in for revolving credit (e.g., credit cards, home equity lines of credit) and not installment loans (e.g., student loans, personal loans).

For example, let’s say you open a new credit card to consolidate the balances on multiple existing cards. Once you have the new card, you will have a higher overall credit limit. But after the transfer, then the debt you’re carrying on all of the cards will be the same, thus lowering your credit utilization ratio.

There are, however, two situations in which this would not be the case:

1) Charging up the credit cards that you just returned to a zero balance. This basically negates all the good debt consolidation does, not only relative to your credit score but your bank account thanks to the added interest you’ll be paying on all that extra debt.

2) Closing the credit cards that you just returned to a zero balance. Ideally, you want to keep those open so you can benefit from all of that available credit. But it only helps if you’re not using it. Sure, it’s fine to make charges to those cards, but never more than you can afford to pay off by the due date. If you doubt you can do that, close the cards. Yes, you’ll be losing the good those cards could do for your credit utilization ratio, but that’s preferable to charging up a bunch of new debt that puts you in a worse position than when you started.

Good Credit Mix

The greater the variety of your credit lines, the better.

Credit mix affects 10 percent of your credit score. That could present a good opportunity to mix things up when you consolidate.

For instance, if it’s credit cards you want to consolidate, consider taking out an installment loan. Provided you keep the credit cards open once they’re paid off (recommended), then it’s a good credit mix. This can be especially helpful if you don’t already have installment loans in your credit history.

On-Time Monthly Payments

If consolidating your debt makes it more manageable, you’ll have an easier time making in-full, on-time monthly payments, which can only do good things to your credit score.

Other Things to Consider

Interest rates. Ideally, you want your new consolidated debt to have a lower interest rate than what you were already paying. If you’re looking to do a balance transfer to a new credit card, find one with a zero percent introductory interest rate. Just do the math and make sure you are able to swing the necessary monthly payments to pay off the balance before the regular interest rate kicks in.

Length of the loan. If you are taking on a new installment loan for your debt consolidation, look at how long it’s going to take for you to pay off the debt. It’s important to know exactly how much consolidating your debt is going to cost. You may find it’s not worth the expense.

Using a debt consolidation company. The debt consolidation you can do on your own should not be confused with hiring a debt consolidation company to negotiate with your creditors. You do not need a third-party to facilitate this process. You can consolidate your debts on your own.

Your current credit standing. You’re going to need good credit to qualify for decent interest rates on a new credit card or installment loan. If you don’t have that, and you’re having trouble making payments, contact your creditors to see about working out a more manageable payment plan and get started with DIY credit repair.