Debt consolidation won’t give you bad credit when handled correctly, but it may temporarily lower your credit score. A debt consolidation loan or a balance transfer credit card can hurt your score due to the hard inquiry from the application and the drop in the average age of your accounts. You could also suffer credit score damage from the change in your credit utilization and from debt settlement companies posing as debt consolidation companies. In the long run, though, if you do things correctly, debt consolidation is likely to help your credit.
To see how debt consolidation may affect your credit, you can use WalletHub’s free credit score simulator. You can also learn more about common effects below.
How Debt Consolidation Can Affect Your Credit
Hard inquiry: A hard inquiry occurs when financial institutions “pull” your credit history when you try to open a new loan or credit card account. One inquiry will likely drop your credit score by 5 to 10 points, but many inquiries within a short time may have a bigger impact on your score. If you make a few months of timely payments, however, your score should go back to normal.
Decrease in the average age of your accounts: If you use a new loan or balance transfer credit card to consolidate credit card or loan debt, the average age of your accounts will decrease. Credit score calculations include the “age” of your open loans and lines of credit. The longer your accounts are open and used responsibly, the better your credit will be.
Change in your credit utilization: Credit utilization is the percentage of your credit limit that you’re using. Consolidating multiple debts on a new credit card could lead to high credit utilization on that card, which could hurt your score. However, the faster you pay off what you owe, the better your utilization ratio will become. Consolidating debt with a loan moves the debt to an account that does not factor into your overall credit utilization. Therefore, your overall utilization decreases.
Debt settlement posing as debt consolidation: When choosing a form of consolidation, be wary of debt settlement companies posing as debt consolidation companies. These settlement companies “help” you consolidate by negotiating with your creditors to reduce how much you owe. This seems helpful, but the companies will actually withhold funds from your creditors until they reach a settlement. In the end, debt settlement is a huge blow to your credit score.
Overall, debt consolidation won’t give you bad credit when you handle it well. Some tips to help you stay on track with your debt consolidation include sticking to a strict payment schedule, making a budget and monitoring your spending habits. If you do handle things correctly, your consolidation is likely to help your credit.
Consolidation loans do hurt your credit in the short-term because the lender will do a hard inquiry into your credit when you apply, dropping your credit score by 5 to 10 points, and your total debt may go up. But even though a consolidation loan will hurt your credit at first, it can lead to a much higher score over time.… read full answer
How a Debt Consolidation Loan Can Help Your Credit
Ideally, your debt consolidation loan will have a lower interest rate than your original debts, which means interest will accrue less quickly and you will be able to get debt-free sooner. Paying off your debts in full will increase your credit score.
In addition, every month as you make payments on your debt consolidation loan, the lender will report information about the loan to the credit bureaus. If you always pay on time, you should see your credit score steadily increase over the life of the loan. If you miss payments or default on the loan, that would hurt your credit.
Debt consolidation is a bad idea if it does not save you any money. This happens when the interest rate on your new loan or line of credit ends up being higher than that of your existing debts, which mostly defeats the purpose of consolidation. In that case, the only benefit would be having all your debts in one place. Debt consolidation may be a bad idea in other situations too, like if you work with a misleading company or consolidate right before a major purchase.… read full answer
When Debt Consolidation Is a Bad Idea
When the APR is higher than on your existing debts
When your "debt consolidation" service is really debt settlement
But even if your credit score is in good shape, you still have to watch out for the wrong types of companies, as well as make sure there aren't any major purchases in your near future.
Debt Settlement Services Disguised as Debt Consolidation
One major situation where debt consolidation is a bad idea is if you're using a "debt consolidation" service that actually turns out to be a debt settlement company instead. Rather than negotiating for a lower interest rate, debt settlement companies try to get your issuer to accept a lump sum and forgive the rest of your balance.
The problem is that debt settlement is a negative item that remains on your credit report for 7 years. In addition, debt settlement companies often have you avoid making payments to the lender for a while to get better negotiating power. That's very bad for your credit score, too. On top of all that, debt settlement companies can charge expensive fees.
Debt Consolidation Before a Large Purchase
Debt consolidation is a bad idea if you're about to buy a house or a car. Getting a debt consolidation loan or line of credit will damage your credit score in the short term because of the hard credit pull triggered by the application. Working with a debt consolidation company also damages your credit if you default during negotiations.
If you're about to make a major financial decision that requires a credit check, you want your credit to be as good as possible. However, at other times, debt consolidation can be a good idea. The credit score damage from applying for a debt consolidation loan is usually limited to 5 to 10 points, which you can rebound from after a few months of on-time payments.
You can predict how debt consolidation might impact your credit score by using WalletHub's free credit score simulator.
Debt consolidation is a good idea for borrowers with high-interest debts owed to multiple lenders. Whether or not debt consolidation is wise depends largely on if you can get a new loan or credit card that will save you money compared to the current cost of your debts. The simplicity of a single payment can be helpful, too.… read full answer
How Much You Can Save With Debt Consolidation
Typical Debt Consolidation Loan
Number of Debts
* Interest rates are from WalletHub data and total interest is calculated on a 2-year basis.
When Debt Consolidation Is a Good Idea
When it gets you lower rates
If you’re able to qualify for a new loan or line of credit with a lower APR than your current creditors are charging, consolidating the debts will reduce the overall cost of what you owe by slowing down the rate at which interest accrues. That in turn will help you pay off what you owe more quickly.
When you’re having trouble managing your payments
If you find yourself with too many individual debts that are hard to keep track of, and you risk missing monthly due dates as a result, consolidating can help simplify your finances.
When the fees aren’t excessive
If you have a credit score of 660+, you should be able to qualify for a personal loan with no origination fee. And some balance transfer credit cards for scores of 700+ have no balance transfer fees. Other loans and cards may charge fees that increase what you owe by 1% to 8%, which might make debt consolidation a bad idea.
When you can get enough funding
Depending on how much you owe and how high your credit score and income are, you might not qualify for a large enough loan or credit limit to accommodate all your existing debts. In that case, you might consider consolidating partially, or you might decide that opening a new account isn’t a good idea.
When you’re not about to make a major financial decision
In the long run, debt consolidation can help you get debt-free more quickly and raise your credit score. But it will cause short-term credit score damage from the hard inquiry required to open a loan or credit card. This could affect your approval odds or the rates you get for things like auto loans or mortgages for up to a year.
In conclusion, debt consolidation is a good idea when it helps you get organized and obtain better rates. You can click on the button below to compare the best debt consolidation loan offers on WalletHub.
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