How Does Debt Consolidation Affect Your Credit?

Debt consolidation will impact your credit score, but how much and for how long will depend on which consolidation method you choose.

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You want to get out from under that mountain of debt, but you are worried that consolidating your debts will hurt your credit.

It’s a valid concern. You want to solve the problem, not make it worse.

The good news is that debt consolidation can have a positive effect on your credit.

Debt consolidation combines your credit cards bills into one manageable, lower-interest pile, with one monthly payment.

There are many debt consolidation options; some have a bigger impact on credit than others. The most common are debt management plans, personal loans and credit card balance transfers, but you may also consider a home equity loan or line of credit (HELOC) or taking out a 401(k) loan.

How Much Does Debt Consolidation Hurt Your Credit Score?

Most debt consolidation methods will temporarily lower your credit score for a variety of reasons. For example, debt management plans ask you to quit using your credit cards. If you cancel a card, that reduces the amount of credit you have available and that can lower your credit score.

When you apply for a consolidation loan, lenders make a “hard inquiry” on your credit, which lowers your score by a few points. If you’re shopping for the best option and there are several inquiries within a limited period, generally 14-45 days, the credit bureaus treat it as one inquiry. Inquiries spread over more time, however, will be seen as desperate attempts for credit and have more of a negative impact.

Other impacts of debt consolidation depend on the method. Loans and balance transfers have many potential negative effects, debt management plans very little.

No matter which method you choose, the biggest factor on how debt consolidation impacts your credit is how you treat the credit you have. Late payments on loans, credit cards and other bills hurt your credit score. A payment that’s 30 days late stays on your credit report for seven years.

Making payments on time is the absolute best thing you can do to maintain good credit or repair poor credit.

Not accumulating more debt after making a debt consolidation move is also important. Don’t think that paying off credit cards bills with a consolidation loan means you’re free to go back using the cards recklessly again. That’s inviting more trouble.

Credit Factors Affected by Debt Consolidation

Many debt consolidation options will have minor negative impacts on credit, but remember, they’re temporary. They will also have long-term positive effects.

The three major credit reporting bureaus – Experian, Equifax and TransUnion – take several things into account when determining a credit score.

Negative Affects on Credit

  • Credit applications trigger hard inquiries that temporarily lower credit scores by a few points; several applications over an extended period will have a greater effect.
  • A new account has no payment history, until on-time payments are consistently made.
  • The average age of credit accounts drops with a new account; the older the average, the better.
  • If debt is transferred to a card with a lower credit limit, credit utilization rate will increase and that will lower your credit score.

Positive Affects on Credit

  • The credit utilization rate will decrease if debt is transferred to a card with a higher limit, or if a credit balance is paid off with a loan.
  • On-time payment history always will strengthen your credit score in the long run.

Consolidating Debt with a Personal Loan

A personal loan is a good way to consolidate debt if you have a good credit score, 680 or above. The lower your credit score, the harder it is to get a loan that makes financial sense, if you can get one at all. High interest rates and fees may erase any costs savings.

To keep the negative impact on credit low, borrow only what you need to pay your debt down. If you take out more than you need, you’re increasing your debt load, and it could be negative.

And a reminder, if you don’t want the loan to have a negative impact on your credit, be financially responsible.

“If you get a consolidation loan and keep making more purchases with credit, you probably won’t succeed in paying down your debt,” the Consumer Financial Protection Bureau advises.

As with everything, there are pros and cons to consolidating debt with a personal loan.

Pros of Debt Consolidation Loans

  • Interest should be lower than what was being paid for credit card debt.
  • Combines several bill payments into one monthly payment.
  • Payments are the same amount every month and are for a fixed amount of time, usually 3 to 5 years.
  • They don’t require as high a credit score as balance transfer cards do.
  • They can decrease the credit utilization ratio.
  • They are unsecured, unlike a home equity or other collateral-based loans.
  • Some come with special offers, like direct payment to creditors, free credit score monitoring, hardship flexibility and more.

Cons of Debt Consolidation Loans

  • Must have a good credit score to get the best interest rate.
  • Loan fees may apply.
  • Prepayment and exit fees can make the loan cost more than expected.
  • If it’s used to pay off credit cards, and the cards are still in use, it could increase debt.

» More About: The Pros and Cons of Debt Consolidation

Consolidating Debt with a Balance Transfer

Balance transfers, in which credit card debt is transferred onto a lower-interest or zero-interest card, works if you have a good to excellent credit score, meaning 700 or better.

If you fall below 700, you may not qualify and if you do, it will likely end up costing you money in fees, a short time limit on the introductory rate and you’ll be back where you started. Or worse.

Pros of a Balance Transfer

  • A lower initial interest rate, generally 0% APR for those with good to excellent credit scores.
  • Combining credit card debt onto a lower-interest card with one monthly payment.
  • Can improve credit by lowering credit utilization rate.

Cons of Balance Transfer

  • Transfers can’t be made using cards from the same bank.
  • Most cards charge a transfer fee between 3%-5%; e.g., if you’re transferring $5,000, it will cost between $150 and $250.
  • Most transfers must be completed within 60 days from opening the account, or you miss out on the 0% APR.
  • The low interest rate is for a limited time – typically six to 18 months – then the rate increases to somewhere near 24% on whatever balance remains.
  • If you use the card for purchases, the 0% rate may not apply.
  • Card issuers usually limit the amount that can be transferred to a percentage of total credit limit or specific dollar amount, and they include fees in the calculation.
  • Can hurt credit score if cards that debt was transferred from continue to be used, upping debt and credit utilization amounts.

» More about: How to Consolidate Debt Without Hurting Credit

Other Ways to Consolidate Debt

There are other ways to consolidate debt, some of which have little or no negative impact on your credit score, though could have a long-term positive impact as the debt is paid down.

Debt Management Plans

A debt management plan consolidates debt with little immediate negative impact on credit and potential long-term positive impact. It doesn’t involve taking out a loan or increasing credit, and your credit score is not an eligibility factor. You make one fixed monthly payment to a nonprofit debt management company, usually for three to five years. The company distributes the money to your lenders. The plan is noted on your credit report , but comes off once it’s completed. Closing credit card accounts may slightly lower a credit score, but timely payment of bills will improve credit rating. Debt management plans come with a monthly administrative fee.

Home Equity Loan or Line of Credit

Homeowners can use the equity in the home for a one-time, lump-sum loan or line of credit (HELOC) to consolidate debt. It has the same impact on your credit score as any other loan, meaning your score will improve if you make on-time payments and will suffer if you miss payment.  Since you’re using your house for collateral, a worst-case scenario is that you lose your house if you don’t make on-time payments. A home equity loan is similar, but a lump sum rather than a revolving line of credit.

Borrowing from Your 401(k)

A 401(k) loan is a loan you make to yourself from whatever a retirement savings plan. It has no effect on your credit. It will, however, cost you money.  If you withdraw the money before turning 59 and a half, you will be assessed a 10% penalty and then taxed on the amount you withdraw. You’re also not accruing interest on what was previously tax-free income you were investing in your retirement. It’s not a good option, so exhaust other ones first.


Filing for bankruptcy is an extreme measure and only an option if there is no other solution. It has a negative effect on your credit. A Chapter 7 bankruptcy stays on your credit report for 10 years. A Chapter 13 bankruptcy stays on your credit report for seven years. Both can have a negative impact on buying a house, renting an apartment, buying a car and more.

How Debt Consolidation Can Help Your Credit

If done right, debt consolidation will have a positive effect on your credit. It shrinks your debt and sets a foundation of consistent on-time payments, which can send your credit score soaring.

But where do you start?

The Consumer Financial Protection Bureau advises, “If you’re having trouble with credit, consider contacting a credit counselor first,” before jumping into debt consolidation.

Working with an accredited credit counselor is a good way to explore debt relief options and decide what the best way to consolidate debt is for your financial situation.

Accredited nonprofit credit counseling agencies offer free counseling, and counselors will help you review your budget, evaluate debt consolidation alternatives and suggest solutions. There are also for-profit agencies that charge a fee for counseling.

Before connecting with a counselor, do some research online.

» Check out our list of the top credit counseling agencies

About The Author

Maureen Milliken

Maureen Milliken has been writing about finance, banking, investment, entrepreneurship, real estate and other related topics for more than 30 years. She started as the “Business Beat” columnist for the now-defunct Haverhill (Mass.) Gazette and currently is one of the hosts of the Mainebiz business-focused podcast, “The Day that Changed Everything” in addition to her daily writing. She also is is the author of three mystery novels and two nonfiction books.


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