Will Debt Consolidation Negatively Impact Your Credit? – NFCC

Editor’s note: This post was originally published in May 2019.

Most people in debt are looking for a way out, ASAP! If you’re struggling to meet your debt payments, you’ve probably considered all the different ways to reduce your payments and get out of debt faster: debt management plans (DMPs), debt consolidation, debt settlement or even bankruptcy.

For a solution that can reduce your monthly payments without destroying your credit, debt consolidation may be one of the best options. While debt consolidation doesn’t eliminate any of your debt, it can help you become debt-free faster. Plus, it can help you improve your credit scores in the long run, as long as you make your monthly payments on time.

What is debt consolidation?

Debt consolidation involves using a credit card or a loan to pay off several debts. The “consolidation” part refers to the fact that you transfer several debts into one account. As a result, you will have fewer monthly payments to manage.

How can debt consolidation help you? There are several main ways that debt consolidation can help someone who is in debt:

• Lower rates: If you move your debt to an account with lower interest rates, you can save money on interest charges. Because more of your money then goes toward the balance sheet, you can also get out of debt faster.
• Lower payments: There is a chance that consolidation will reduce your total monthly debt payments. This can happen if you have lower interest rates and/or if your repayment is extended over a longer period of time.
• Easier management: Rolling multiple debts into one account gives you fewer payments to make and fewer dates and balances to track.

With that said, it is not a magic solution. Debt consolidation does not erase any of your debt. So for some people, it just becomes a way to move the debt without paying it off.

If debt consolidation isn’t available to you, perhaps because you can’t qualify for a new loan or because the payments are still too high, consider a debt management plan (DMP) instead.

How does debt consolidation affect your credit?

Debt consolidation will definitely have an impact on your credit scores. But many consumers mistakenly assume that the impact is negative.

The truth is that debt consolidation can initially cause your credit scores to drop. However, if you make your monthly payments on time and pay off your debt (rather than racking up new fees), your scores can improve drastically. Here’s what to expect:

• Difficult searches: When you apply for a credit card or loan, your scores will take a hit. This is also known as a difficult investigation. According to FICOeach difficult question usually costs you five points or less.
• Closing accounts: If you close an account after consolidation, you may see a drop in your credit scores. This is because you may have less credit available. To minimize the impact, avoid closing old credit cards unless you’re afraid you’ll be tempted to use them.
• Monthly payments: Your payment history is the biggest factor used to calculate your credit scores. If you make timely payments on your debt consolidation, you can usually expect to see a slow increase in your scores. If you miss a payment, your scores can drop quickly.
• Repayment of debt: Lowering your total debt can help your credit scores improve significantly. If your interest rates are lower, you can pay off your debt faster and see your credit scores rise faster. However, if you keep racking up new debt, your scores may not improve.
• Credit mix: If you don’t have any loans credit reportsgetting a personal debt consolidation loan can improve your “credit mix,” which makes up 10% of your FICO credit score.

Common mistakes with debt consolidation

Debt consolidation can be complicated. So it’s important to approach it carefully and avoid these common mistakes that damage your credit:

• Ignoring conditions: Most people use balance transfer credit cards to consolidate debt. But these cards tend to have deliberately confusing terms. For example, they usually come with a 3% or 5% fee on the debt you transfer. So if you transfer $5,000, your fee could be $150 or $250. If you don’t understand the terms, you could also end up losing your 0% APR early.
• 0% APR traps: The 0% APR offer on a balance transfer credit card will last for a limited time only. After that, the APR can go up to nearly 30%. If you don’t have a plan for paying off the debt before then, you could end up deeper in debt than before, with higher interest rates.
• Increase in debt: For some people, debt consolidation can seem like an invitation to load up their balances on old cards. But if you keep racking up more debt, your finances will suffer, and so will your credit scores.

Debt consolidation can be a huge win for your credit

In short, you can expect to see your credit scores drop slightly after you consolidate your debt. However, if you stay on track with your payments and reduce your overall debt balance, you can expect to see your credit scores improve.

Still not sure if debt consolidation is the best solution for you? An NFCC certified credit counselor can help you figure this out. When you meet with a counselor (in person, by phone or online), they will answer all of your debt management questions and can recommend the best solutions based on your exact situation.

Andrew Rombach is a content contributor for Lendedu – a website that helps consumers and small business owners with their finances.