Does Debt Consolidation Affect Your Credit Score?

Does Debt Consolidation Affect Your Credit Score?

By Lizzy Martini

If you’re struggling with a heavy debt load, you might be considering debt consolidation as a way to reduce your monthly payments and/or pay off your loans sooner. But does debt consolidation affect your credit score? Does debt consolidation hurt your credit, or help it?

 

The answer depends on which method you choose for debt consolidation. Let’s explore the various debt consolidation options and see how each affects your credit score. We’ll start with a quick review of how debt consolidation works.

 

How Does Debt Consolidation Work?

Debt consolidation generally means using one loan, credit card or service to pay off multiple loans, which can include revolving debt like credit cards or installment debt like personal loans. Instead of making payments to multiple creditors each month, you’ll make one payment to one entity. Debt consolidation can potentially lower your interest rate, reduce your monthly payment and/or shorten the time it takes to pay off your debt.

 

Here are the most common options for debt consolidation—and a rundown on how each can affect your credit score:

 

Debt Consolidation Loan

An installment loan allows you to consolidate multiple types of debt, including credit cards, medical bills and other types of loans. Installment loans have a set payoff date and let you make monthly or biweekly payments. It may be possible to lower your overall interest rate or reduce monthly payments when you consolidate debt with an installment loan.

 

Impact on your credit score
Whenever you apply for new credit—whether it’s a credit card or installment loan—a hard inquiry will be recorded on your credit report, which can have a minor negative impact on your credit score. The effect is relatively short-lived.

 

If you use the money from an installment loan to pay off credit card debt, your credit score could go up because you may be improving your credit utilization ratio. Your credit utilization ratio represents the percentage of your available credit that you’re using. For example, if you have credit card balances totaling $4,000 and your credit limits add up to $8,000, your utilization ratio would be 50%.

 

Your credit utilization ratio accounts for about 30% of your FICO score, making it a highly influential factor. Most experts recommend keeping your credit utilization ratio at 30% or less. That applies to the ratio for each individual card, and for your utilization across all cards.

 

It’s important to note that your credit utilization ratio will improve only if you leave the credit cards open after paying them down. Closing a credit card reduces your overall credit limit, which would negatively impact your credit utilization ratio and credit score.

 

Over the longer term, making on-time payments on your debt consolidation loan can help improve your credit score, since payment history is the most influential factor for your credit score.

 

Credit Card Balance Transfer

If you only want to consolidate credit card debt, you may be able transfer current credit card balances to just one card. This is often accomplished using a new card with a low introductory interest rate, with the intention of paying off the balance before the intro period ends and the interest rate increases.

 

Impact on your credit score
Your credit score may initially decline if you’re opening a new card, thanks to the hard inquiry. Your credit score may also decline due to changes in your credit utilization ratio. Loading all your balances onto one card might drive up your credit utilization ratio and drag down your credit score.

 

As with all debt, if you make timely payments on the balance transfer, your credit score should benefit over the longer haul.

 

Debt Management Plan

Also known as a DMP, these plans are offered by credit counseling agencies as part of a program that includes personal finance education. Instead of giving you a new loan, the agency negotiates lower payments with your creditors on your behalf. You make one regular payment to the agency, and they turn around and pay your creditors. Agencies often require that you close accounts so that you don’t accrue any new debt.

 

Impact on your credit score
Enrolling in a DMP will trigger a “DMP” notation on your credit report. But this alone isn’t cause for concern.  As long as the agency makes on-time payments on your behalf, there should be no impact on your credit score.

 

Closing accounts, however, can negatively affect your score (as noted above), but as you establish an on-time payment history with the DMP, your credit score can improve over time.

 

Debt Settlement Program
Offered by specialized firms and lawyers, debt settlement programs aim to reduce the amount you owe.

 

Once you sign up for a debt settlement program, you’ll stop making payments on your outstanding debts, and start making payments into an escrow account set up by the debt settlement program. When you have enough built up in the account, the firm contacts your creditors and offers to make a lump sum payment to wipe out the debt. The lump sum offered is less than the total amount owed. There is, however, no guarantee that settlement negotiations will work.

 

Impact on your credit score
Missing payments while you wait to settle debts will hurt your credit score. Once you settle the debt, your credit report will be updated to show a “Settled” status—which is slightly better than an “Unpaid” status, but anything other than “Paid in Full” is considered negative for your credit score.

 

After you’ve settled the debt, you can focus on rebuilding your credit score.

 

At a glance: Does debt consolidation affect your credit score?

 

 

Impact on Credit Score

Debt Consolidation Loan

(-) Minor short-term drop from hard inquiry
(+) Potential boost from improved credit utilization ratio
(+) Boost from on-time payments

Credit Card Balance Transfer

(-) Minor short-term drop from hard inquiry
(-) Potential drag from worsened credit utilization ratio
(+) Boost from on-time payments

Debt Management Plan

(+) Boost from on-time payments
(-) Potential drag from closed accounts

Debt Settlement Program

(-) Hurt by missed payments
(-) Hurt by “Settled” status

 

Apply for an online installment loan with RISE today and see if a debt consolidation loan could brighten your financial future. RISE helps you take control of your debt. You’ll benefit from rates that go down over time* and free access to your credit score.

 

* Customers in good standing may qualify for a reduction in annual percentage rate ("APR"). Installment Loan Customers: In order to be eligible, you must continue to meet RISE's credit criteria, and we will evaluate the stability of your personal information and identity for each new loan.  If eligibility requirements are met and you make 24 successful, on-time monthly payments (48 bi-weekly payments), the APR for your next loan will be 50% off your original loan's APR (excluding customers with starting rates of less than 75%). Additionally, if you continue to meet eligibility requirements and you make 36 successful, on-time monthly payments (72 bi-weekly payments), you will qualify for a 36% APR for your next loan.  Note that it may take two or more loans to reach 36% APR.  (In Mississippi, if you make 24 monthly payments (48 bi-weekly payments), the monthly handling charge for your next loan will be 50% off (excluding customers with starting rates of less than 75%).  And, if you make 36 monthly payments (72 bi-weekly payments), you qualify for a monthly handling charge of 3% for your next loan with RISE.  Note that it may take two or more loans to reach a 3% monthly handling charge.) Line of Credit Customers: In order to be eligible, you must continue to meet RISE's credit criteria, and we will evaluate the stability of your personal information and identity. If eligibility requirements are met and you make 24 successful, on-time monthly payments (48 bi-weekly payments), the APR on your line of credit will be reduced to 50% off your original APR. Additionally, if you continue to meet eligibility requirements and you make 36 successful, on-time monthly payments (72 bi-weekly payments), you will qualify for a 36% APR on your line of credit.

Next Article: What Credit Score Is Needed for a Personal Loan?