Does debt consolidation hurt your credit score?

In today’s tough economic climate, many households are feeling the squeeze. With inflation cooling but still impacting the cost of everyday expenses, high interest rates driving up the cost of borrowing and a challenging job market making it tough to find new employment, more people are turning to their credit cards to help cover essentials and fill in budgetary gaps. This trend has led to $1.14 trillion in total credit card debt across the nation, a record high.

But while credit cards can be useful when you need a short-term borrowing option, they also come with some of the highest borrowing rates. Right now, the average credit card rate is near 23%, so any unpaid balances you carry can quickly spiral out of control, leaving you struggling to keep up. Over time, the compound interest charges could make it tough to maintain even the minimum payments — which could explain the growing number of delinquent credit card accounts nationwide. 

For those who need to tackle their credit card debt, credit card debt consolidation could be a solution worth considering. Debt consolidation involves combining multiple debts into a single loan, typically with a lower interest rate and more manageable repayment terms. Before pursuing this option, though, it’s crucial to understand how it might affect your credit score.

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Does debt consolidation hurt your credit score?

In general, pursuing debt consolidation won’t negatively impact your credit score — at least not in the way that other debt relief options, like credit card debt forgiveness, could. That said, the impact of debt consolidation on your credit score isn’t exactly straightforward. 

Debt consolidation can have both positive and negative effects on your credit depending on a range of factors and how you manage the process. Here’s how:

• Credit inquiries: When you apply for a debt consolidation loan, lenders typically perform a hard inquiry on your credit report. This can cause a temporary decrease in your score, typically between five and 10 points.
• New account opening: Taking out a debt consolidation loan means opening a new credit account. This can lower your average account age, which is a factor in credit scoring models. The effect is usually minor but could lead to a slight score decrease.
• Credit utilization: Consolidating credit card debt into a personal loan can significantly improve your credit utilization ratio on your revolving accounts. This could positively impact your score, as lower utilization is generally viewed favorably.
• Payment history: Consistently making on-time payments on your debt consolidation loan can strengthen your payment history over time, which is the most heavily weighted factor in most credit scoring models.
• Account closures: If you close your credit card accounts after consolidating their balances, it might affect your score by reducing your amount of available credit and altering your credit mix.

The extent of these effects varies based on your existing credit profile. Those with higher credit scores might see a more noticeable initial drop due to the inquiry and new account. However, those who already have damaged credit due to high utilization or missed payments might experience less severe impacts or even see faster improvement.

It’s important to note that while debt consolidation may cause a short-term dip in your credit score, it could still be a better alternative to struggling with unmanageable debt or considering more drastic measures. Over time, with responsible management, your score can recover and potentially surpass its pre-consolidation level.

Find out more about debt consolidation and your other debt relief options here.

Is debt consolidation right for your situation?

Determining whether to consolidate your debt requires careful evaluation of your financial circumstances and goals. As you weigh your options, be sure to consider these factors:

• Total debt amount: Debt consolidation typically benefits those with substantial debt (of over $10,000) the most. If you have a smaller amount of debt, other strategies, like balance transfers or budgeting adjustments, might be more suitable.
• Current interest rates: Compare your existing credit card interest rates with potential consolidation loan rates. If you can secure a significantly lower rate on a loan, consolidation could save you money and accelerate the debt repayment process.
• Financial capacity: Assess whether you can consistently meet the payments on a consolidation loan. While this option can simplify your debt, you still need to ensure the new monthly payment fits your budget.
• Credit score priorities: If maintaining a high credit score is crucial for imminent plans like a mortgage application, weigh the potential short-term impact carefully. However, if you’re willing to accept a temporary dip for long-term financial stability, consolidation could be worthwhile.
• Spending patterns: Be honest about your ability to avoid accumulating new debt while paying off the consolidation loan. Consolidation isn’t a cure for underlying financial issues.
• Loan conditions: Carefully review the terms of any consolidation loan, including fees, prepayment penalties and whether the interest rate is fixed or variable, to determine whether it makes financial sense.

The bottom line

While debt consolidation can offer a path to more manageable debt repayment, it’s not without complexities. The impact on your credit score can vary, potentially causing initial declines but offering opportunities for long-term improvement. For those struggling with high-interest debt and seeking a way out, though, the benefits of consolidation may outweigh temporary credit score fluctuations.