Home > Managing Debt > Will Debt Consolidation Help or Hurt Your Credit?

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From student loans to a house mortgage, debt accumulation is stressful and overwhelming. As you make moves to get out of debt, you might want to consider consolidating credit cards or other loans to save you time and money. But that begs the question—does debt consolidation help or hurt your credit?

The answer depends on how you consolidat­e and what you do with your debt afterward.

1. Debt Consolidation Loans

Getting a new loan to pay off other debts is the most popular way to consolidate. It’s certainly what most people think of when they consider consolidation. But finding a loan that has decent terms and is designed specifically for the purpose of consolidation can be challenging—especially if your credit scores are a bit lower due to the balances you’re carrying.

It’s certainly not impossible, though. Look for reputable debt consolidation companies that will work for your specific situation.

Tip: Triple check lenders’ certifications to make sure you’re dealing with a legitimate site if you’re shopping for a loan online. Scams abound.

Effect on Your Credit: Consolidating credit cards with high balances using an installment loan (i.e. a loan with fixed monthly payments) may actually benefit your credit rating, especially if you use the loan to pay off credit cards that are near their limits. At the same time, any new loan can cause a short-term dip in your credit scores—so don’t be too surprised if you see your credit score change slightly when taking out a new loan.

2. Debt Management Plans

Debt management plans are often confused with debt consolidation—however, they’re very different programs. Debt management plans (DMPs) are offered through credit counseling agencies and, much to many people’s surprise, they don’t actually consolidate your debt.

Instead, you make a “consolidated” payment to the counseling agency, which then pays each of your creditors—usually at a reduced interest rate. Even though you’re making only one or two monthly payments, the counseling agency doesn’t actually pay off your creditors for you—it simply acts as a middle man to help you repay your debts and ensure that the creditors get the money they’re owed. These programs are available regardless of credit scores, so if you are having trouble consolidating, a DMP might be worth considering.

Tip: If you choose to move forward with a DMP, you should close or suspend your credit card accounts. Unfortunately, you’re not permitted to use credit cards while enrolled in a DMP.

Effect on Your Credit: If you have a good credit score and adhered to a creditor’s repayment terms in the past, a DMP could have a negative impact on your credit as it indicates that you are experiencing or have experienced difficulty with payments. Also, since a DMP directly impacts payment terms, credit reporting agencies might ping your DMP commitment because it designates a change in payment policies.

3. The Credit Card Shuffle

Transferring a high-rate credit card balance to a card with a lower rate is another way to consolidate. Carrie Rocha, author of Pocket Your Dollars: 5 Attitude Changes That Will Help You Pay Down Debt, and her husband paid off some $60,000 in debt, and taking advantage of low-rate balance transfers was one of the strategies they used to dig out. However, if you decide to go this route, you must be very disciplined in your approach. Otherwise, you may fall into traps such as getting stuck with a balance at a high interest rate after the introductory period ends.

Tip: Read the fine print. Keep your eyes peeled for any “but” or “until.”

Effect on Your Credit: It depends on how you use a transfer. You’ll often see a temporary dip in your credit score when opening any new card. If you use a substantial portion of the available credit (on the card) to consolidate balances from other cards with lower balance-to-available-credit ratios, your credit scores may drop from that as well. Finally, you may also lose points if you open a new card and use a majority of the credit line to consolidate.

However, if a 0% card allows you to save money and pay off your debt faster, you can come out ahead in the long run, both financially and credit score–wise.

The End Goal: Less Debt Equals Stronger Credit

Paying down debt can have a tremendous impact on your credit scores. According to FICO, the company behind most of the credit scores used by lenders, consumers with high credit scores (e.g. 785 and above), tend to keep their balances low. Specifically, two-thirds of consumers with good credit carry less than $8,500 in non-mortgage debt, and they use an average of 7% of their available credit on their credit cards.

That means that paying off debt—whether you use a consolidation loan or just put every penny you can toward your debt—will often improve your credit ratings in the long run. The biggest risk, though, is that it’s easy to run up new balances on the cards you paid off in the consolidation—and that’s definitely not a good move for your credit or your bottom line. As you make progress on paying off your loans, periodically check your free credit report to see where you stand.

Remember, moving debt is a means to your end. The goal is to pay off those balances and free up cash flow as well as to help build strong credit. So whether it’s a consolidation loan, credit card shuffle, or DMP, know your options so you get there just a little faster.

Image: mapodile

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  • P Zeal

    Hi Gerri, I think it is great how you actually respond to poster’s issues. For the vast majority of blogs and forums, questions from readers go ignored. Very nice.

    • Jeanine Skowronski

      We do try to help our readers where we can!

      Thanks for the feedback!


  • CreditHurts?

    I was thinking of getting a loan thru Lending Club to pay off my credit cards which is a total of 8,500. I do not have any other loans or debt to pay off and no car payments- my credit cards are the only debt I have… on paper – I do owe my parents money that I pay on a monthly basis. The reason I would like to get this loan is because the interest of 2 of my credits cars are high and I cannot keep up with them. My credit score is in the upper 600’s if I take this loan out will it hurt my credit score? I am planning on paying these debs off by next year and start to save to buy a home. I am just thinking if this would be my best option to pay these credit cards quicker.

    • http://www.Credit.com/ Gerri Detweiler

      Actually, as I mentioned in the article, a debt consolidation loan may help your credit score because installment loans are treated somewhat differently in scoring models than revolving accounts. If this option saves you money and helps you get out of debt faster it sounds like it will be a good move in the long run.

  • francis

    Hi I’m thinking of doing a consumer proposal I’m aware that it will impact my credit for at least 3 years or so, But what I would like to know is do banks have an internal record keeping, meaning will I be black listed on their records for infinite, any advise is appreciated.

    • http://www.Credit.com/ Gerri Detweiler

      I am not sure what you mean by a consumer proposal – do you mean a debt management plan through a counseling agency or a hardship plan? Or do you mean that you plan to try to negotiate a settlement for less than the full amount? Either way, it is possible that you will not be able to get another card with them, either for a while or ever. Nevertheless, there are many card issuers out there and once you have dug out of debt you can rebuild your credit, and try for a card with another issuer that doesn’t have that information.

  • Denise

    Hi Robin! What does SoFi stand for?

  • AJH

    Is there a reputable loan consolidation company to work with someone whose credit is 540+ ?
    Truly needing help. Planning on purchashing a home in 2017

    • http://www.Credit.com/ Gerri Detweiler

      What do you mean by loan consolidation company? Are you talking about credit counseling? We wrote more about that option here:
      Does Credit Counseling Work?

  • http://www.Credit.com/ Gerri Detweiler

    Robin – I don’t feel comfortable advising you on the specifics of what might help/hurt when it comes to getting a mortgage. I’d encourage you to sit down with an experienced loan officer for that discussion. There are a lot of moving parts here and mortgage lending requirements can be very specific. I wouldn’t want to suggest an action that could hurt your ability to get a home.

    And as much as I’d like to help I am going to sound like a broken record here but please sit down with a counseling agency that also does student loan counseling. Again, you have a lot going on here and I think you would be well served by someone who can spend the time with you to go over everything–income, expenses, debts, interest rates etc.. Getting a review session wouldn’t obligate you go into a repayment plan. They work with consumers in these situations every day and should have some good ideas for you. A couple of agencies I know are doing this kind of counseling include Cambridge Credit Counseling and Money Management International. Cost is reasonable and in my opinion, well worth it.

    I hope that helps!

  • http://www.Credit.com/ Gerri Detweiler

    Robin – I’d still suggest at least talking with the counseling agency as they may have some good suggestions for you. The 8.5% rate sounds good. If you can afford the lower rate on the second loan, then go for it, but if it would be a stretch and you might find yourself in debt again then stick with the other loan and just try to pay it off faster. (This is where the counseling agency may be helpful; they can go over your budget with you and may have some ideas you hadn’t thought of…) As for leaving some of it in savings, it might not be a bad idea to have at least 3-6 months of payments set aside just in case. If you pay off the loans faster then you expected you can apply it to the payments at a future date. As far as closing your accounts go, if you can avoid it leave them open. Closing all but one will no doubt have an affect on your credit scores but it’s hard to say how much. If you really don’t want the temptation, though, then you’ll have to weigh that against the hit to your credit. Hopefully things will go well and I can feature you in a success story in the future! Rooting for you. 🙂

  • Jessica

    Me and my husband have about $15,000 in credit card debt. We are in an apartment right now and have 2 car loans, one is not a big amount, and were wanting to buy a house in the next year. Would that affect our credit score too much when we try to buy a house?

    • http://www.credit.com/ Credit.com Credit Experts

      Jessica —
      It would be a good idea for you and your husband to start tracking your credit scores (there are many ways to do this; you may get a free score with one of your credit card statements, or you can get them online. Credit.com offers a free credit report snapshot, updated every 30 days, that explains why your score is what it is and suggests ways to improve it.) Here’s how to monitor your credit score for free. But basically, you’ll want to pay down your credit card debt as much as you can, make sure all your payments are made on time, and avoid applying for any new credit.

      • Xavier Ramos

        Hello, I am Kind in the same situation, me and my wife have $13,000 in loans debt ( three different loans ) I would like to get a loan to pay off these 3 loans, because we’re paying over $550 a month with these 3 loans payments, I would like to reduce my monthly payments to start saving money to buy a house, my credict score its about 699 and my wife’s credict score is in the upper 600s… I have a car loan.. Would that affect our credict score ? Or What do you think its the Best move…?

        • http://www.credit.com/ Credit.com Credit Experts

          Xavier —
          Depending on interest rates you’re paying, it’s possible that you’ll be able to . . . but if you can bring up your credit scores, you’ll likely get better terms, saving you money. If all your credit is in the form of installment loans, you may want to get a credit card (but keep the balance low and pay it off in full every month). You could also consider talking with a credit counselor about your options.

  • http://www.Credit.com/ Gerri Detweiler

    Robin – I’d suggest you talk with a reputable counseling agency that helps with both credit card debt and student loans. They can go over your finances and help you come up with a plan. I don’t have a comprehensive list of all agencies that offer that service, however, I do know the agency we interviewed for the following article does: Does Credit Counseling Work?

  • anamorphic_skeptic

    Hi Gerri,

    this is the best blog I’ve found answering just that question about personal debt consolidation vs. maxed credit card debt. Thank you! We make excellent income so the debt to income is low, however we are doing a major renovation/flip so maxed out or credit cards to cover those costs. Now our scores have taken a hit and we’re getting stung looking at a new car loan. The situation is temporary, this house will sell this summer so we’ll have all that cash back to pay off the CC debts, but in the interim we need to build back our credit and make things more manageable so we can refinance our primary house in the fall (from a construction loan) and qualify for a large truck loan. Over time the interest $ is a wash, if we weren’t to pay it all off when the flip sells, but I just want to make sure this is the best plan for the next 6+ months to help our credit. I was approved for a personal loan to pay off all the CC debt, the interest rate is 2 points higher so I will ask if they can do something on that, but ultimately I just don’t want the new loan to give us another FICO hit, at least not by the end of the 6 months.

    • http://www.Credit.com/ Gerri Detweiler

      It’s hard to say exactly how it will balance out. A new loan often does temporarily drop the scores but with FICO scores utilization is a big factor – and probably bigger if yours is high.

      Thanks for the kind comments! Glad you find the blog helpful.

      • anamorphic_skeptic

        I think it’s the best option at this point, I’ll try to remember to update in a few months so other readers have an example as well. We’re just under 700 fico now and its held steady thru many changes so I’m not sure how else to increase it, or what could make it worse anyway! Just hoping this may do the former.

  • http://www.Credit.com/ Gerri Detweiler

    The car loan is different than the credit cards when it comes to maxing out the loan amount. (A car loan is an installment loan so the debt usage ratio isn’t much of an issue there, if at all.)

    If you want to consolidate the credit cards, that’s fine but you don’t need to worry about doing the same with the car loan. The only reason you might want to consolidate the car loan would be because you can get a better interest rate. But I would not recommend you consolidate the car loan with either a higher rate loan or a longer term loan.

  • Psychoholic

    If I get a loan and say I’m paying off a car in that loan do I still have to have full coverage on my car? I was looking into a loan from lending club to pay all my credit cards and her car loan off so we can just make on easy monthly payment thanks..

    • http://www.credit.com/ Credit.com Credit Experts

      A lender may often require more coverage on a car when it is their collateral for a loan, but once the car belongs to you (and the loan is paid off), you are free to drop coverages not required by your state. Some owners of older cars decide to drop comprehensive and collision coverages, for example. (Canceling liability coverage is never a good idea.)

  • doober

    What about consolidating student loan debts? Would that help credit overall? I have several student loan debts that have defaulted, but I have been on a payment plan for around 6 months. Will consolidating now help me?

    • http://www.Credit.com/ Gerri Detweiler

      Student loan consolidation is a different animal. Are you currently in rehabilitation on your student loan? If so you want to complete your rehabilitation program so you can get out of default. You can also check the National Student Loan Data System to learn more about your options.

  • http://www.Credit.com/ Gerri Detweiler

    As we mention in the article, over time it can help your credit. Initially there may be a dip due to the new debt but if you pay it off on time if should even out. There are no guarantees, of course, but that is often how it works. And keep in mind the main goal – to get out of debt!

  • ElbonianGA

    One problem with a debt consolidation personal loan: some scoring models lower your credit score if you have too many installment loans. For instance, if you have two car loans and take out a Lending Club or Prosper loan for consolidation purposes your credit score can go down on some models simply because you now have 3 installment loans. The size of the payments on all of your installment loans can also be a factor that some models consider.

    Nonetheless, a Lending Club loan did work for me to get out of the 600s and into the 700s for a few weeks between the time I used the loan to pay down my credit cards and before the Lending Club loan was reported on my credit report (becoming my 3rd installment loan). In that interim time period I applied for a Discover IT card with a 0% APR and further consolidated my remaining credit card debt onto that card. Now, I just need to pay off one of my two car loans and then I’ll hopefully get back into the 700s once again…..

    • P Zeal

      Wow, I never thought about this trick working with credit cards/installment loans. There was a time when people used to pull this off with mortgage loans – i.e., applying for 2 mortgages almost simultaneously, but now lenders pull another credit report prior to closing to detect any changes. I’m sure that wouldn’t happen with credit cards and installment loans. Gotta keep this in mind. Thx.

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