At times, it can be overwhelming or even impossible to pay off credit card debt in a timely manner. Debt consolidation can be a great option to lower monthly payment and/or pay it off faster. But is there a catch when it comes to your credit?
In some cases, debt consolidation can help your credit score. But in other cases, it can hurt your score. It can also depend on which option you use for consolidation, since there’s more than one way to consolidate your debt.
Read on to find out which option is best for you.
Table of contents:
How a personal consolidation loan can affect your credit
Since this falls into the credit category, applying for a personal consolidation loan will result in a hard inquiry on your credit report. As a result, your credit score may decrease by a few points.
Getting a new loan can also decrease your credit age, which measures the average age of all your accounts. But how much it decreases your score depends on how many other accounts you have and the age of each of those accounts. The more, old accounts you have, the less a new account will decrease your credit age. This factor accounts for 15% of your score.
Luckily, loans do not affect credit utilization, which comprises 30% of your overall credit score. Getting a loan won’t drive up this ratio.
And if you manage the personal consolidation loan effectively by making payments on time, your credit history and score will be in good standing. Conversely, missing payments will have the opposite effect. Credit history is the biggest factor in credit score, carrying 35% of the weight in your score. As a result, any missed loan payment would have a serious negative impact.
How a debt consolidation program can affect your credit
Otherwise known as a debt management program or plan, this will help you pay back everything you charged with one low monthly payment. Your interest charges will also be reduced, aiding you in getting out of debt faster.
However, as part of this program, all of your accounts will freeze and close as you pay them off. This may cause a small decline in your credit score. For two reasons:
- Closing old accounts would decrease your credit age
- Closing any accounts will drop your total available credit limit, which can increase your credit utilization ratio
However, keep in mind that you’re also paying off your debt as you go, which would improve your utilization ratio. You also build positive payment history because the creditors agree to accept adjusted payments through the program.
So, the impact of this type of consolidation depends on where your score started. If your credit score is extremely high when you started the program, you may see a slight drop. On the other hand, if you score was extremely low when you started, it can increase as you complete the program.
A warning about missed payments when you first start the program
When you start a debt management program, you’re adjusting the payment schedule for your credit cards. You stop making payments directly to your creditors and start making payments through the credit counseling agency that sets up your program. But until your program officially starts, you must continue making minimum payments to your creditors. If you don’t, you can end up with missed payments.
It’s important when you set up the consolidation program that you’re clear about when your payments will start and when you can stop paying your creditors directly. A highly rated credit counseling organization will make sure that happens. That way, you avoid any credit damage. But miscommunication may lead to issues.
How a balance transfer credit card can affect your credit
Because of its 0% interest from 6 to 18 months, a balance transfer credit card is a great way to pay off debt, especially if that debt had a high interest rate. Keep in mind that applying for a balance transfer credit card will show up as a hard inquiry on your report and can also reduce the age of your credit accounts, bringing down your credit score slightly. But it will benefit you in the long run, and you can easily increase your score later on.
However, the old adage of debt still applies: Any time you miss a payment, you hurt your credit score. So if you consolidate your debt by transferring credit card balances, you shouldn’t have any credit damage unless you miss a payment.
Unfortunately, some people get into bigger trouble with debt after they consolidate. Why? Because once the debt is consolidated, you’ll have zero balances on all of your credit cards. It can be really tempting to start spending before you pay off the consolidated debt.
Always finish paying off consolidated debt before you start charging again. Otherwise, you can have a real mess on your hands and can ruin your credit in the process.
Monitor your credit closely after you consolidate
Whether you use a loan, a balance transfer card, or a debt management plan to consolidate, it’s always a good idea to keep an eye on your credit report. You want to make sure that the balances on your individual accounts reflect that they have been paid down. You also want to watch out for misreported missed payments.
If you find any errors in your credit report following consolidation, you should go through the credit repair process. This will allow you to correct the negative items that may be dragging down your score.
Debt.com can help you find the best option to consolidate debt.
Article last modified on March 20, 2023. Published by Debt.com, LLC