Does debt consolidation impact your credit score

If you have a single loan to repay, you can try various ways of reducing the interest rate. But if you’re paying off multiple debts at the same time, it may become difficult to keep track of the various payments every month, especially when each loan has a different interest rate.

debt consolidation
A good way to reduce your monthly debt payments is to apply for debt consolidation. It helps lower your overall interest rate. But how does it impact your credit score? Any time you apply for a loan, a hard inquiry is made on your credit. This reduces your score a bit. But this should not be much of a problem if you have good financial practices in general.

In this article

Take a look at what debt consolidation is, how it helps you reduce your debt payments and how it impacts your credit score. 

What is debt consolidation?

Instead of making multiple payments to various debts, a debt consolidation loan gives you the money to pay off all your loans at once. Then, you make a single payment every month, usually at a lower interest rate, till you pay off the consolidation loan. It’s that simple.  There are two ways in which this works. One, through a personal loan, and two, through a balance transfer card. 

Using a personal loan to consolidate your debt 

This is a straightforward process. You apply for a personal loan and pay off all your existing debt. Then, you make a single payment every month to pay off the personal loan. 

How it helps

  • Compared to a balance transfer card you can get a personal loan with a much lower credit score. 
  • You can consolidate all your current debt into a single loan, making it easy for you to keep track of your monthly payments. 
  • It can improve your credit by adding to your credit mix. If you’ve been using only credit cards, a personal loan will help the credit mix since it is an installment-based loan. 
  • It helps reduce your credit utilization. That is, the amount of credit you use will reduce. And this helps improve your credit score. 

Points to keep in mind

  • If you fail to pay the installments on time, it will hurt your credit score. 
  • It may lead to more debt if you’re not careful. 
  • Some loans charge you a fee if you want to pay off the balance in advance (prepayment). 
  • Some loans charge a high APR for borrowing. 

Using a balance transfer card to consolidate debt 

How it helps

  • If you have a very good credit score, you can an excellent rate of interest. 
  • No penalty or fee is charged if you choose to pay the balance in advance.
  • Payments are highly flexible. 

Points to bear in mind

  • It usually requires a much higher credit score when compared to a personal loan. 
  • If you fail to pay off the entire balance before the offer date ends, you can be charged a higher rate of interest. 
  • Since your credit utilization is high, it will negatively impact your credit score. 

What are your other options? 

If you feel that neither of these two debt consolidation methods will work for you, you can check out the other options available. 

401(k) loan

This loan does not impact your credit score in any way since it doesn’t reflect on your credit report. 

Home equity loan

This is essentially a line of credit, so your credit score will be impacted due to the credit check. Also, you will get either a revolving account or a term or installment loan. 

Debt management plan

Companies that offer debt management services can help you in negotiating your dues with your creditors. Applying for this plan doesn’t impact your credit score. But when you negotiate to pay a lower amount compared to how you actually have to pay, it can affect your credit score. In addition to this, your existing credit card accounts may be closed so that you don’t use any more credit till your debts are paid off. This will impact your credit score since the closure of credit accounts is a negative action for credit evaluation. 

A debt consolidation loan will impact your credit score only to a small extent. Since a hard check is done on your credit history while applying for it, it impacts your score. But a personal loan can improve your credit mix. And if you pay all the installments on time, it will help improve your score. In general, responsible financial practices will help balance any negative impact on your credit score due to debt consolidation. 

This page is purely informational. Line does not provide financial, legal or accounting advice. This article has been prepared for informational purposes only. It is not intended to provide financial, legal or accounting advice and should not be relied on for the same. Please consult your own financial, legal and accounting advisors before engaging in any transactions.

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