Does Debt Consolidation Hurt Your Credit?

If you’re facing debt, you’re surely not alone. Over three-quarters of U.S. adults carry some type of debt, according to Forbes Advisor. This may include credit card debt, student loans, a mortgage, auto loans and other types of debt. If you have a few of these obligations in your credit mix, your monthly bills can start to pile up quickly – but that’s where debt consolidation can help.

Debt consolidation can be a great way to manage your monthly payments and potentially get a lower interest rate. But consolidating your debts also means you’re taking on a new debt payment – at least temporarily – which can affect your credit.

So, is debt consolidation the right solution for you? In short, it depends. Let’s find out how debt consolidation can impact your credit score and the potential implications of this change.

Will Debt Consolidation Hurt My Credit?

Consolidating your debt can make debt repayment more manageable, but it’s important to also understand how debt consolidation can affect your credit score.

Your credit will take an initial hit when you consolidate your debt. Debt consolidation requires you to open a new credit account, so the average age of your accounts will decrease. Opening a new account also usually comes with a hard inquiry, which can drop your credit score by a few points as well.

As long as you make on-time payments, though, your credit score will improve over time. As you pay your balance down, your credit utilization ratio will also decrease. Many financial experts recommend using no more than 30% of your available credit limit, but less is always better. Credit utilization makes up about 30% of your credit score, so a lower credit utilization ratio can significantly improve your score.

Whether these long-term benefits outweigh a temporary drop in your credit score depends on your situation. Understanding how debt consolidation works is important as you consider its impact on your credit.

How Does Debt Consolidation Work?

The process of debt consolidation is a debt management strategy where you take out a new loan for an amount that covers several debts. In doing so, you replace multiple debts with one monthly payment. Consolidating debt can make budgeting easier, and if you have a lower interest rate than the average interest rate of your previous debt payments, you may be able to pay your debt off faster.

Common debt consolidation options include personal loans, balance transfer credit cards, home equity loans and home equity lines of credit (HELOCs). However, home equity loans and HELOCs are only available to homeowners.

Let’s explore, in greater detail, the strategy of consolidating debt with a personal loan or a balance transfer credit card.

Debt Consolidation With A Personal Loan

With a personal loan, you roll all your current debts into one new loan with a fixed monthly payment. It might seem like a backward solution to take out yet another loan, but this can lower the chance of forgetting payment due dates and sending in a late payment. Since a personal loan is an installment loan, you also have a defined term over which you’ll pay off the loan in full.

Debt Consolidation With A Balance Transfer Card

With a balance transfer card, your existing debt is moved onto a new credit card. This method can require you to pay an initial upfront cost, known as a balance transfer fee, that’s often 2% – 5% of your total balance. However, many card issuers offer cards with a 0% APR introductory period that often lasts a year. You can make interest-free payments toward your balance within this defined time period.

This method can be risky, though. While the promotional period offers you a leg up, you’ll likely face a very high interest rate once it ends. If you can’t pay off your debt in the amount of time you anticipated, you could owe a lot of money in interest moving forward.

Should I Consolidate My Debt?

Debt consolidation can be beneficial for the right individual. Consolidating debt can help you pay less in interest and simplify your monthly payments. However, debt consolidation is only a short-term solution. If you continue to rack up credit card charges, your debt will continue to grow.

Also take note that only the most creditworthy people tend to land a particularly favorable interest rate. As you consider debt consolidation, check your credit report and credit score to see if you’ll qualify for an ideal rate.

You may also want to talk with a financial professional who can help you decide if debt consolidation is right for you. They can assist you in choosing the best solution for your needs and provide tips on how to avoid falling back into debt.

4 Debt Consolidation Alternatives

If debt consolidation isn’t a good fit for you, perhaps consider trying one of the alternative methods discussed next.

1. Reevaluate Your Budget

If you can manage your monthly payments on your own, consider setting a strict monthly budget. This can help you evaluate your current income and expenses to see if you have any extra funds to put toward debt payments. Consider tackling your debt in a different way, such as the debt snowball or debt avalanche method.

2. Use A Debt Management Plan

Trying to pay off multiple debts at once can become overwhelming. If you feel like you need assistance, you may want to consider enrolling in a debt management plan. With this kind of plan, you make one monthly payment to a credit counseling agency. The agency then makes your payments to lenders on your behalf.

3. Consider Debt Settlement

If you’ve tried other solutions and are still struggling to manage your debts, you could consider debt settlement, where you negotiate with creditors to lower the amount of debt you owe them. However, you can negotiate this yourself or use a professional debt settlement company.

In any event, debt settlement should be a last-resort option. That’s because this method can be extremely risky. Consider, for example, that not all creditors will accept your negotiated settlement. Debt settlement also typically stays on your credit report for 7 years and can adversely affect your credit score.

4. File For Bankruptcy

Filing for bankruptcy can help you get out of debt in dire circumstances. For instance, maybe you’re unable to make payments or get approved for a debt consolidation loan. If you’ve exhausted every other option, bankruptcy may be a viable option to consider.

With bankruptcy, you can legally file to wipe out some or all of your debts. However, your bankruptcy remains on your credit report for 7 – 10 years. This negative mark can complicate applying for future financing. Like debt settlement, bankruptcy should be reserved for when all else fails.

Final Thoughts: Consider Your Finances To Determine If Debt Consolidation Is Right For You

If debt consolidation allows you to pay off the debts you owe faster than you otherwise would, this strategy is a worthwhile one and will likely boost your credit in the not-too-distant future.  However, for the reasons we’ve highlighted, your credit score will likely take an initial hit when you consolidate your debt.

If you’re unsure of the best next step for your financial future, you could consult a credit counselor to learn more. If you think a debt consolidation loan is right for you, start your personal loan application with Rocket Loans^SM today.