Debt consolidation may hurt your credit score a bit in the short term, but consolidating should actually help improve your credit score over time. Debt consolidation is one of the best options available to people who want to pay off what they owe while also saving money and protecting their credit standing in the process.
You can get a better sense of how debt consolidation is likely to affect your credit score in particular by trying WalletHub’s free credit score simulator. You can also learn more about debt consolidation and its impact on credit below.
Key Things to Know About Debt Consolidation & Your Credit
- Debt consolidation involves using a new loan or line of credit to pay off existing debts in order to get a lower overall interest rate and a more manageable monthly payment.
- The hard inquiry from applying for a loan or credit card can temporarily hurt your credit score.
- Consolidating can help you save money, pay down what you owe faster, avoid missing payments, and improve your credit score in the long run.
- Unlike other alternatives – such as debt management, debt settlement and even bankruptcy – debt consolidation won’t damage your credit standing in any significant manner when you do it right.
How Does Debt Consolidation Affect Your Credit?
It’s hard to know exactly how much debt consolidation will affect your credit score since it depends on multiple factors, including the extent of your credit history, your open accounts and the actions you take after consolidation. But you can get a pretty good idea of when it is likely to both help and hurt your credit below.
When Debt Consolidation Might Hurt Your Credit
Debt consolidation can negatively affect your credit score in the beginning, since the lender may do a hard inquiry into your credit history when you apply for a debt consolidation loan or a balance transfer credit card. Hard inquiries typically cost you about 5-10 credit score points, with the damage lasting up to 12 months.
Consolidation could also hurt your credit if you miss payments on your consolidated debt. However, the payments should be more manageable than they were prior to consolidating.
When Debt Consolidation Will Help Your Credit
Debt consolidation will help your credit if you make the payments on your new loan or credit card by the due date every month. On-time payments add positive information to your credit report, which leads to a better credit score.
In addition, consolidating will be most beneficial if you take advantage of the opportunity to stabilize your financial situation and minimize your debt. Owing less overall reduces the chances of missing payments, defaulting and getting sent to collections in the future.
Learn more about how debt consolidation affects your credit.
What Happens to Your Credit After Debt Consolidation?
What you do after you’ve consolidated your debts into a single loan or line of credit can have a greater impact on your credit standing than the act of consolidation itself. After all, debt consolidation merely makes your debt easier to deal with; it doesn’t reduce what you owe or address the underlying issues that caused you to get into debt in the first place.
So, if you want to use debt consolidation as a bridge to debt freedom and credit improvement, you must make sure to:
Adhere to a Strict Payment Schedule
It’s essential that you carefully evaluate the affordability of a debt consolidation loan or line of credit before opening it and that you make the necessary monthly payments thereafter. Otherwise, you’ll just wind up missing payments, wasting money on interest, and incurring credit score damage all over again. The only difference will be that you’ll have wasted a lot of time and debt consolidation may no longer be an option for solving your problems.
The best approach is to use a calculator to determine how much you can afford to allocate toward debt payments each month. This will give you a sense of what type of debt consolidation is feasible as well as whether or not you’ll have to adjust how much you spend on other things.
Make a Budget
A budget is necessary to prevent history from repeating itself in an overleveraging sense. This might seem like basic advice, but only 2 in 5 consumers maintain a budget, according to surveys from the National Foundation for Credit Counseling.
One simple way to devise an effective budget is to make a list of your expenses from the last few months, calculate how much you’ve spent per month, and eliminate those expenses that you can’t afford and that are unnecessary. In doing so, don’t forget to include your monthly debt payments.
Monitor Your Spending & Payment Habits
A budget only works if you stick to it. You therefore need to regularly monitor your monthly expenses as well as your ability to pay for them and adjust accordingly. The Island Approach can be a helpful ally in this pursuit.
More specifically, now that you have all of your debt consolidated into a single account, you should open a credit card account to use purely for everyday expenses. You should always be able to pay for such purchases in full, so if finance charges show up on this account at the end of a given billing period, you’ll know that you’re overspending.
Debt consolidation can be a helpful way to organize your debt obligations as well as garner a lower interest rate and a more manageable monthly payment in the process. The act of consolidating your balances can affect your credit in the short-term given that it likely requires opening a new loan or credit card. However, the manner in which you manage your consolidation account and conduct your finances thereafter will have a far greater bearing on your credit standing when all is said and done.
If you manage your financial obligations responsibly after debt consolidation, it will turn out to be one of the best decisions you could have made for your wallet. You can check your latest credit score for free on WalletHub and track your progress daily. You’ll also get personalized credit-improvement advice.