Does Debt Consolidation Hurt Your Credit Score?

When you’re ready to get out of debt, sometimes it’s hard to know which path you should take. For some people, debt consolidation will be the best option because it can allow you to group all your debt together, thereby making it easier to manage your debt – and in some cases lowering your monthly payment and interest rate at the same time (see our article on how debt consolidation works).

Does debt consolidation hurt your creditBut of course, before you can decide if it’s the right choice you have to answer some important questions. One of the most important is, “does debt consolidation hurt your credit score?”

To answer that, you need to understand how credit reports and credit scores work. If you’re not familiar with the process, here’s a very brief explanation: Your credit report contains information about all the credit accounts you’ve ever had, including mortgages, auto loans, credit cards, student loans, etc. Also included in your report is a history of the payments you’ve made on time, and those you have paid late (or not paid).

The 3 major credit bureaus (Equifax, Experian, and TransUnion) compile this information and make it available, along with your credit score, to lenders who want to find out how creditworthy you are. In theory, debt consolidation should not have a major impact on your credit score. However, the fact is, debt consolidation can improve or hurt your credit score. It depends on your particular situation and your ability to pay off debt.

Here are the questions you must answer in order to figure out if debt consolidation will hurt or help your credit in the long run:

1. What Type of Debt Consolidation Will You Do?

There are three main ways of doing debt consolidation:

  • credit card balance transfer
  • home equity loan (or Home Equity Line of Credit)
  • standard debt consolidation loan from a bank or debt relief company

Each of these three methods requires a hard inquiry on your credit, which is the same as when you apply for a new credit card, submit a rental application, or get an auto loan. The hard inquiry will lower your credit score by a few points and stays on your credit report for two years. However, this small hit to your credit is not necessarily a reason not to do debt consolidation.

2. How Will Debt Consolidation Affect Your Credit Utilization?

A bigger concern than the hard credit inquiry is how the debt consolidation might affect your credit utilization. The phrase “credit utilization” simply means the percentage of your available credit that you are currently using. If you have 3 credit cards, each with a credit limit of $5,000, and you have $1,000 of debt on each card, then your total credit limit is $15,000 and your total debt is $3,000 – which means that your credit utilization is 20%.

So how do the different types of debt consolidation affect your credit utilization?

If you make use of a balance transfer offer and move all your balances to a new credit card, you will immediately increase your total credit limit. Using the example above, let’s say you transferred your three credit card balances onto a new card. Now you have $3,000 on your new card, and it has a credit limit of $5,000. You also still have your old cards (with a total credit limit of $15,000), so your total credit limit is now $20,000 and your credit utilization is 15%. In this scenario, your credit score will likely improve!

But wait, what if you decide to close those 3 old credit cards? Then your total credit limit would only be $5,000 and your credit utilization would be 60% – which is well above the recommended threshold and would certainly hurt your credit score!

The same kind of calculation is true if you get a home equity loan or a standard debt consolidation loan: your credit score will likely improve if you keep your old credit cards open, but it will get hurt if you close them. Of course the problem is that there is an inherent temptation in leaving those cards open. Which brings us to the next question…

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3. Will Debt Consolidation Make You Spend More… or Less?

How well do you know yourself? Can you predict whether you’ll be tempted to spend more money if you suddenly have more credit available? As explained above, doing debt consolidation can hurt your credit if you close your old accounts afterward. But you can’t leave them open if you’re going to start spending on them again – after all, that defeats the whole purpose of using debt consolidation to destroy your debt, right?

This is why it’s important to know yourself and be realistic about your future behavior. If you know for sure that you won’t be tempted by leaving those old accounts open, then you can feel comfortable doing debt consolidation and knowing it will not hurt your credit, aside from the relatively minor impact of the hard inquiry.

However, if you think you might be tempted to continue racking up credit card purchases after doing debt consolidation, then you have to make a harder decision. If you can find a debt consolidation loan that will help you pay off your debt through lower interest rates or lower monthly payments then you should probably do it – and close your old credit cards despite the potential negative impact on your credit score.

After all, paying off your debt will help improve your credit score in the long run and save you plenty of money in interest and fees!

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Hopefully the information above is helpful not only in answering the question “does debt consolidation hurt your credit score?” but also in giving you tools to decide what the best course of action is in your particular situation.

Remember, when considering whether to do debt consolidation, compare how these factors would be affected by the loan:

  • Your expected time to being debt free
  • Your long term interest rate
  • Your monthly payments
  • Your credit utilization rate

If you have any questions about the information above and how it might relate to your own individual situation, please post a comment below and we’ll do our best to answer it. And for further reading, check out our article, “Is Debt Consolidation a Good Idea?

This article is part of our Debt Consolidation Resource Center.  If you’re looking for additional information about debt consolidation, be sure to pay a visit!

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  • jay g

    HI, I have a follow up question to the above really great explanation. We can consolidate and not run the cards up again. But how soon can my husband get his credit rating up from a high-fair to good. I am also at around 711, so I don’t want mine to go down either. This need for the good credit ratings soon is for college funds coming up. We will either redoing our HELOC or get college loans.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Hi there, the truth is it really depends on the individual situation. I wouldn’t be able to say for sure, but the good news is we’ve heard many cases of people improving their score significantly in six months or so. Best of luck to you!