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 include getting a personal loan or a balance transfer card. Both types require a hard inquiry on your credit, which can lower your credit score by a few points.
But if you change the habits that led to debt and pay on time, every time, the overall effect should be positive.
Here’s a closer look at the potential impact on your credit when you consolidate your debt with a personal loan or balance transfer credit card.
How debt consolidation can affect your credit
Consolidating with a personal loan
- Generally requires a lower credit score for approval than a balance transfer card.
- Can help improve credit mix if you had only credit cards before, because it is an installment loan.
- Can combine several payments into one, simplifying your finances.
- Can improve credit by lowering the amount of credit limit you’re using, known as credit utilization, if unsecured credit card bills are moved to an installment loan.
- It can lead to even more debt if you use newly available space on credit cards.
- If you end up overextended and unable to pay, late payments can damage credit.
- Paying high fees to borrow money (be sure you understand the APR).
- Having a prepayment penalty (some do not, so check).
Consolidating with a balance transfer card
- Lower interest rate (often for a set time), including a 0% APR for excellent credit consumers.
- Flexible payments.
- No prepayment penalty.
- A lower credit score because of high credit utilization.
- Not paying off the debt before the offer runs out (the downside of flexible payments), resulting in higher interest rate.
If those options don’t seem like a good fit, there are other debt consolidation options that also can affect your credit.
Keep in mind it’s generally not a good idea to replace unsecured debt (like credit card debt) with secured debt (like a mortgage or car loan) because you could lose your home or vehicle if you can’t pay.
- Home equity loan or line of credit: Will be reported as an installment loan or revolving account, depending on which you get. You’ll also get hit with a credit check.
- 401(k) loan: Does not appear on your credit report, so it has no effect on your credit score.
- Debt management plan: Seeing a credit counselor and signing up for a debt management plan does not directly affect your credit score, but negotiating to pay less than the full amount due or closing credit cards can hurt your score. A DMP is noted on your credit report while it is in effect, but not after the plan is completed.