Does Debt Consolidation Hurt Your Credit?

Shortly after you begin the process, you may notice a dip in your credit score. However, debt consolidation may ultimately help your credit score as long as you maintain healthy financial habits.

Ways debt consolidation can help your credit score

If you manage your credit card responsibly, debt consolidation should help you overcome your debts and have a positive impact. The following are some of the ways debt consolidation may help your credit score:

• Improves your credit mix. A credit card balance transfer may help your credit score if you’ve previously only had a student loan, mortgage, personal loan, or another installment loan. While credit mix accounts for a small portion of your credit score, lenders typically like to see a mix of revolving accounts and installment accounts.
• May reduce your credit utilization ratio. Your credit utilization ratio is the total portion of your available credit in use at a given time. Credit utilization makes up a significant portion of your credit score. Ideally, debt consolidation should make paying down your credit card balances easier—especially if you’ve found a card with a lower interest rate. Your credit utilization should shrink as you pay down your balance, which is good news for your credit score.
• Builds a positive payment history. With multiple credit card and personal loan bills on your plate, you might easily lose track of a due date and miss a payment. Debt consolidation may leave you with fewer payments to remember, so it’s harder for a due date to slip your mind.

Ways debt consolidation can hurt your credit

Debt consolidation doesn’t guarantee a better credit score. The habits and decisions that lead to unmanageable debt could undermine the positive impact of debt consolidation. Here are some ways debt consolidation may hurt your credit score:

• May increase your credit utilization ratio. Credit card balance transfers typically cost a small fee that amounts to a percentage of the balance you’re transferring. That amount adds to the total you owe. Adding to your outstanding balance could increase your credit utilization, which may hurt your credit score.
• Lowers the average age of your credit accounts. The age of your credit accounts has a small impact on your credit score. By opening a brand new credit card account, you may lower the average age of your credit (especially if you close other credit card accounts). While this may not do much damage, it could compound other issues.
• Requires a hard credit check. When you apply for a new credit card, the credit card issuer typically conducts a hard inquiry into your credit report. Hard credit checks often lower credit scores slightly. Your score may quickly recover from one hard credit inquiry as long as it’s followed by responsible credit card use.

Credit card debt consolidation best practices

A few best practices may help you get the most out of your debt consolidation and minimize risk to your credit score.  

• Set a budget and stick to it. Make sure you take on only debts that you can afford to repay. Avoid overspending on other expenses, too. If you miss payments because you can’t afford them, you could quickly end up in a difficult situation.
• Develop a payment plan. Make sure you choose a debt consolidation method with terms that work for you. To avoid adding too much interest to your balance, plan to repay it before the end of the introductory period.
• Make more than the minimum payment. Whenever possible, try to pay a little extra. That way, you can pay down your balance more quickly and reduce your credit utilization ratio.
• Avoid accruing a balance on your credit cards. You may not want to close your credit card accounts after you transfer the balances to your new card, as this reduces your total available credit and could increase your credit utilization ratio. However, if you’re tempted to use an old card after you’ve completed a balance transfer, getting rid of your physical cards could help you avoid overspending.
• Set up autopay. Autopay could help you avoid missing payments. Just make sure you maintain enough in your account to cover the expense on the due date each month.
• Compare lenders. Use pre-approval tools to find the best credit card balance transfer offer. Consider interest rates, introductory offers, and repayment terms.

The bottom line

Debt consolidation may help you get out from under multiple debts. However, the long-term effect on your credit score largely depends on your decisions. Healthy habits, like minimizing your credit utilization and paying your credit card bills on time, are key for building and maintaining a solid credit history.

Not sure if debt consolidation is right for you? Credit counseling can help you figure out the best way to tackle your debt.