Can Debt Consolidation Hurt Your Credit?
If you ever find yourself in a situation where you have multiple loan or credit card repayments to make each month, then lumping them all together into one payment can seem like a good idea.
It’s an approach known as debt consolidation, which is favored by many people.
But, before you take this approach to pay off debt, there are important things to consider as, in the short term at least, it can lower your credit score.
How Consolidating Debt Can Affect Your Credit Score
There are a number of ways that taking this step can have both adverse and positive effects and these are the main ones. Let's start with the negatives:
- It involves a hard inquiry. Whether you’re applying for a loan or for a credit card with a low or 0% balance transfer rate, it will constitute a hard inquiry that will inevitably lower your credit score by a few points.
- A new account equals greater risk. Each time you open a credit account or take out a loan it means lenders see you as being an increased risk and your credit score reduces accordingly.
- Your average credit will be lowered. In assessing your credit scores, one of the most important factors is how long you have responsibly handled your various debts. By taking out a new loan or credit card it will mean you’ll need to take some time to establish that you’re making regular payments. Until you do, your credit score may be a little lower.
So those are the main negatives that can affect your credit score, but there are several big benefits too:
- Your credit utilization ratio will be cut. When your credit score is being calculated, one of the factors considered is what proportion of our available credit you are using. By opening a debt consolidation account, you will be effectively increasing the amount of credit open to you, therefore, reducing the overall proportion of it that you have borrowed. This is a good thing in the opinion of lenders.
- You’ll be able to improve your payment history. By far the most important aspect of getting a good credit score is being able to show that you can service your debts. So, by consolidating debt into a single monthly payment and consistently meeting monthly repayments, your credit score may steadily rise.
- You’ll have fewer risks of missed payments. When you have a number of repayments to make each month across various credit cards and loans, it can be easy to overlook one or two by mistake. By having just the one repayment it’s easier to remember to pay it, avoiding the risk of damaging your credit score through missed payments.
What’s the Answer?
There are two sides to the answer as to whether debt consolidation will affect your credit score.
Taking out any credit, and even applying for it, will almost inevitably lower it in the short term. That’s because it’s increasing the risk you pose in the eyes of lenders.
But it also gives you the opportunity to show that you are a responsible borrower by making payments when they are due.
So, in the longer term, it may not just help you to pay off your debts more effectively, you may even find yourself with a higher credit score too.