10
Does Debt Consolidation Help Your Credit Score? It Depends.
Debt consolidation is usually billed as a smart financial move, because it can boost your credit score and save you money.
But a few mistakes could actually hurt your credit or cost you more money in the long run. Here’s what to keep in mind when deciding whether to consolidate your debt and how to choose the best way to do it.
Debt consolidation usually means taking out a loan to pay off existing debts, most commonly credit card debt.
These are technically personal loans that lenders often market as “debt consolidation loans,” which isn’t inaccurate. It’s just their way of letting you know how they can help you.
You’ll take out the loan, receive the funds and use them to pay off your credit card balances. Then you’ll repay the loan over time like any other loan.
You could also consolidate with a balance-transfer credit card or other kind of loan, such as a retirement account loan or home equity loan. However, personal loans typically have the advantage of lower interest rates and no collateral requirement.
People with a lot of high-interest debt tend to look to consolidation because it simplifies repayment, and could reduce the cost of the debt through lower monthly payments, a lower interest rate or both.
While debt consolidation usually helps your credit score, there are some pros and cons to consider before you consolidate credit card debt or other high-interest loans.
You might come across companies offering one of several ways to fix your debt. They’ll each have a different effect on your credit score and apply to different situations:
Refinancing works like consolidation, but the term usually refers to paying off a single debt. You pay off one loan balance with a new loan that gives you a better interest rate and repayment terms. Refinance your debt if your credit and finances have improved since you first borrowed.
Debt relief is an umbrella term that includes consolidation and refinancing, and it often includes some amount of debt forgiveness. The term is often used by companies that facilitate debt consolidation or a “debt management plan” — you’re generally better off doing a little research and managing the debt on your own.
Settlement is when you agree with a creditor on a reduced repayment amount that it’ll consider payment in full. This will show up on your credit report and could have a negative impact for several years, but will help you pay off the debt faster.
Restructuring is more common for companies than individuals and usually happens in dire situations. The effect is similar to refinancing, but it involves reorganizing the existing debt rather than replacing it with a new one.
You don’t necessarily need a high credit score to take out a loan for debt consolidation, but better credit gives you a better chance at a low interest rate and favorable terms.
Watch out for predatory lenders if you have a low credit score. Some unscrupulous companies are willing to give you a loan you can’t afford with a super high interest rate. A loan you can’t afford to repay could put you in a worse situation than you are with credit card debt.
Consolidating debt could help your credit score in two major ways:
Consolidation itself doesn’t leave a negative mark on your credit report, like debt settlement does. But the loan (or credit card) shows up as a new credit line, which could temporarily lower your score.
A few common debt consolidation mistakes could hurt your credit score or cost you money. Here are a few tips to make the right decision about whether a debt consolidation loan could hurt your credit score and how to save money in your situation.
After you pay off credit cards, don’t close every account. Having them on your credit report affects these factors that make up your credit score:
Your credit card consolidation loan or balance-transfer credit card is still debt with monthly payments you have to keep up with.
Budget before you take out the loan so you know you can afford the monthly payment. Staying on top of the payments should help your credit score over time — but getting behind will hurt.
If you opt for a balance transfer card — which usually comes with an introductory 0% APR for about a year — plan to pay the debt off during the introductory period. Any longer, and you’ll have to pay interest and probably face a high interest rate and annual fees.
Shop for the best debt consolidation loans before committing.
Consider what kind of consolidation — personal loan, balance transfer card or secured loan — works best for you based on your budget, existing debt and creditworthiness.
Online loan marketplaces can help you quickly see and compare personal loan offers from lenders side by side.
To evaluate a debt consolidation loan, consider:
Maybe your best option now is to take out a loan at a high interest rate and a long repayment term. If that gets you on track with debt payments, it could be what you need to boost your credit score.
Just don’t stick yourself with those bad terms for the long haul.
As your score rises and you get a handle on your monthly budget, consider refinancing the loan to get better terms in the future.
Qualifying for a debt consolidation loan has many of the same requirements as qualifying for any loan. You’ll need to be at least 18 years old, provide proof of citizenship and submit documentation of your current income and the ability to make monthly debt payments at the current interest rates. You’ll also have to meet the lender’s minimum credit score requirement, which is usually in the 600 range for this type of loan.
Many lenders specifically offer debt consolidation loans, but you don’t have to consolidate that way. Instead of working with debt consolidation loan companies, you can choose to consolidate debts through personal loan lenders with lower interest rates. This can be a smart financial move if you have several high interest credit card bills or multiple debts, but your credit score needs to be 650 or above to qualify for unsecured personal loans with most lenders.
The length of time it takes for debt consolidation to affect your credit score depends on how you consolidated the debt. In the instance of a straightforward debt consolidation loan, you should see it improve your credit score within 6 to 24 months. If you’re trying to qualify for another loan like a home equity loan, you’ll want to start the consolidation process up to a year ahead of applying.
Kaz Weida is a senior writer for The Penny Hoarder. Dana Miranda contributed.
Ready to stop worrying about money?
Get the Penny Hoarder Daily
Some of the links in this post are from our sponsors. We strive to provide accurate, reliable information.
Compensation may influence how and where products appear on our site (including their order), and we do not include all companies or offers.