Does Debt Consolidation Hurt Your Credit?

Consolidating debts into one payment that's easier to handle can help your credit and budget, but there are risks.
Jackie Veling
Bev O'Shea
By Bev O'Shea and  Jackie Veling 
Edited by Kim Lowe

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Consolidating your debt can lower your monthly payments, but it can also cause a temporary dip in your credit score. Two common debt consolidation approaches are getting a debt consolidation loan or a balance transfer card.

Any credit application typically triggers a hard inquiry on your credit, which can temporarily lower your credit score. But the overall credit effect of debt consolidation should be positive, if you make sure to pay on time and change the habits that led debt to stack up.

Here’s a closer look at the potential impact on your credit when you consolidate debt.

How does debt consolidation work?

Debt consolidation works by rolling several debts into one, ideally under a lower interest rate, which saves money.

These debts may be across multiple credit cards or a mix of different types of unsecured debts, like credit cards, medical bills and payday loans.

By applying for a debt consolidation product, you’ll either transfer your existing debts to the new product, like in the case of a balance transfer card, or you can use the product to pay off your debts, like in the case of a loan. You’re then left with only your new debt to pay down.

Having fewer payments to juggle helps with budgeting, and cutting the interest rate can help you pay off debt faster, because more of your payment goes toward the debt rather than the interest.

How does debt consolidation affect credit?

Debt consolidation has the potential to help and hurt your credit score, but if you successfully pay off your debt and stay out of debt in the future, the overall effect should be positive.

Ways debt consolidation can help your credit score

  • Builds a history of on-time payments: Responsible repayment behavior is the most important factor in calculating your credit score. If you take out a loan to pay off your debt, and then make all the loan payments on time, it could help build your score

  • Lowers your credit utilization: Your credit utilization, or the amount of available credit you’re currently using, accounts for 30% of your credit score. Generally, the lower your credit utilization, the better your score. If you consolidate your debts, then successfully pay them off, your credit utilization ratio should go down. 

  • Can help diversify your credit mix: Juggling a few different types of credit products may help grow your score. For example, if you have revolving credit, like credit cards, adding installment credit, like a debt consolidation loan, could show credit diversity. 

Ways debt consolidation can hurt your credit score

  • Requires a hard credit inquiry: Applying for a debt consolidation product requires a hard credit check, which temporarily knocks a few points off your credit score. If you’re interested in a debt consolidation loan, pre-qualifying — a way to check for loan offers — can help you compare lenders before submitting to a hard credit check.

  • Could increase overall debt load: One of the main risks of debt consolidation is getting into more debt once your newly freed up credit cards are available to use again. For example, if you move your existing credit card balances to a balance transfer card, then end up using your old cards again, you may have more debt than when you started, which will likely hurt your credit score.

  • May lead to missed payments: In the same way a history of on-time payments can help build your credit score, missing payments can hurt your score. 

How debt consolidation can help your credit score

How debt consolidation can hurt your credit score

  • You can build a history of on-time payments with your new debt consolidation product.

  • You can lower your credit-utilization ratio by successfully paying off your debts.

  • You can potentially diversify your credit mix.

  • Applying for a debt consolidation product requires a hard credit inquiry, which knocks a few points off your score.

  • If you keep charging your credit cards after consolidating them, you could increase your overall debt load.

  • If you miss a payment, your score may suffer.

Ways to consolidate your debts

There are a few different ways to consolidate your debts. The best choice depends on your credit score, how much debt you have and what resources you have available to you.

Apply for a balance transfer card

A balance transfer card is a type of credit card you can move your existing credit card balances onto, and then pay them down all at once. The biggest benefit, though, is that most come with a 0% interest promotional period, sometimes lasting up to 21 months. During this time you’ll pay no interest on your balance, which means you can pay it down faster.

To qualify for a balance transfer card, you’ll need good to excellent credit (690 score or higher). You’ll also want to take into account the balance transfer fee, which is usually 3% to 5% of the amount being transferred. Lastly, keep in mind that like any credit card, a balance transfer card has a limit, so you’ll want to make sure the limit is high enough to cover your total debt.

Take out a debt consolidation loan

If you can’t qualify for a balance transfer card, or the limit is too low to cover your existing debt, consider debt consolidation loans, which are available to borrowers across the credit spectrum and come in amounts of $1,000 to $50,000. These loans have fixed interest rates and fixed repayment terms, so you’ll pay the same amount each month, making the payment easier to budget for, and you’ll know the exact date you’ll be debt-free.

You’ll want to make sure you get a loan with a lower rate than the average rate on your existing debts (NerdWallet’s free debt consolidation calculator can help you calculate this). Once you apply and are approved for the loan, you’ll use the funds to pay off your debts, so you’re left with only the loan payment.

Borrow from your 401(k)

If you have a 401(k), you can borrow up to half the amount, with a $50,000 maximum, to pay off your debts. These loans typically have low interest rates, and any interest you do pay goes back to your 401(k). Still, this is one of the riskier debt consolidation options and should be a last resort.

Taking out a 401(k) loan can significantly impact your retirement, and you’ll lose out on the money you could have made if that money was still invested. Also, if for some reason you can’t repay the loan, you’ll owe taxes and potentially a large penalty. And if you leave your job, the loan may be due soon after.

Tap your home equity

If you own your home, you could use your existing equity to pay off your debts through either a home equity loan or a home equity line of credit.

A home equity loan is a lump-sum loan that you pay back with a fixed interest rate, similar to a debt consolidation loan. A home equity line of credit, or HELOC, works more like a credit card in which you only borrow what you need and typically pay it off monthly.

Keep in mind it’s generally not a good idea to replace unsecured debt (like credit card debt) with secured debt (like a mortgage) because you could lose your home if you can’t pay. Similar to a 401(k) loan, consider this a last resort option.

Other debt payoff options

If the above options don’t seem like a good fit, there are other ways to pay off debt.

  • DIY methods: The debt snowball and debt avalanche are two do-it-yourself debt payoff strategies that can be very effective. With the snowball method, you’ll tackle your smallest debt first and work your way up, building momentum through quick wins. With the avalanche method, you’ll pay off your highest interest debt first and work your way down, applying your interest savings to each new debt. 

  • Credit counseling: A nonprofit credit counseling agency can help you get your debt under control. Counselors may look at your budget (sometimes for free) and provide helpful feedback, including debt counseling or recommendations for a debt management plan

  • Bankruptcy: If your debt is more than 40% of your income and you can’t pay it off within five years, bankruptcy may be an option. Filing for bankruptcy will stay on your credit report for up to 10 years though, so make sure you’ve exhausted all other options.

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