Does debt consolidation hurt your credit?

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by Allison Martin

edited by Deborah Kearns

Updated September 3, 2024

In a nutshell

Debt consolidation can make it easier to get out of debt, but it can also have consequences for your credit. Your credit score may drop when you apply for a debt consolidation loan, but this effect will be temporary if you keep up payments on the new debt.

You can consolidate multiple debts to get a single, more affordable monthly payment and potentially pay your balances off faster.
Some consumers also save a bundle in interest by consolidating high-interest debts using a debt consolidation loan or line of credit, which have their own risks.
After consolidating debt, your credit score may go up because you’ll have lowered your credit utilization rate.

What is debt consolidation?

Debt consolidation involves combining several debts into a single, new loan to simplify the repayment process. This method can be used to tackle unsecured debts, like high-interest credit cards and loans. Some borrowers also consolidate secured debts, like auto loans and student loans.

Types of debt consolidation

There are several ways to consolidate your debt, including:

Debt consolidation loan: This is a type of personal loan designed to pay off debt. The loan is paid to you in one lump sum, which you then use to pay off your old debts. You then repay the personal loan lender back in equal monthly installments over a set term.
Home equity loan: A home equity loan is a type of second mortgage that allows you to convert some of your home equity into cash. You can use the funds however you see fit — including debt consolidation.
Home equity line of credit (HELOC): Also a second mortgage, a HELOC works like a credit card. You get a revolving line of credit to borrow from as needed, and you pay interest only on the amount you withdraw. You can use a HELOC to pay off your existing debts and then repay the HELOC instead.

If you have a 401(k), your employer may also allow you to borrow against it. With this approach, you won’t be taking on added debt, but it’s generally not recommended as it eats into your retirement nest egg.

Pros:

Your credit score will likely improve since consolidating revolving debt means lowering your credit utilization ratio.
If you have a strong credit score, you could get a more competitive interest rate than you currently pay on your debts.
You’ll get a single monthly loan payment that may work better for your budget.
Debt consolidation can help you avoid late payment penalties and adverse credit reporting.
You could eliminate your outstanding debt balances faster.

Cons:

If you reuse the credit cards you consolidate, you’ll dig a deeper debt hole.
Applying for a debt consolidation product will likely drop your credit score by a few points since it generates a hard credit inquiry.
You likely won’t qualify for the best rates on debt consolidation products with a lower credit score.
The length of your credit history, which makes up 15% of your credit score, will drop when you get a debt consolidation loan, potentially lowering your credit score.

How debt consolidation works

Debt consolidation involves rolling several debt balances into a single product, preferably with a lower interest rate than you currently have.

If approved, the lender will pay your creditors directly or disburse the funds to you. The latter is more common, but then it’s your responsibility to pay off your debts with each creditor. Once your balances are wiped clean, you’ll have a single monthly loan payment instead of several to worry about.

How does debt consolidation affect credit?

The impact on your credit score is generally minimal when you consolidate debt. Applying for a loan, line of credit or balance transfer credit card results in a hard credit inquiry that could dip your score by up to five points. Fortunately, the impact is temporary and won’t impact your score after 12 months.

What is the relationship between debt consolidation and credit scores?

Debt consolidation can do more good than harm to your credit score. The ding from the hard inquiry isn’t ideal but the long-term benefits could far outweigh the short-term hit.

Once the consolidation is complete, your credit utilization ratio will decrease. This figure represents the percentage of your available credit limit in use and should not exceed 30% if you’re aiming for a high credit score.

Because your credit utilization ratio accounts for 30% of your credit score, you could see a substantial increase in your credit rating. Of course, it depends on the amount of unsecured debt you consolidate.

However, reverting back to using your credit cards once the balances are consolidated means you might end up with more debt than you started with, so be disciplined with your plastic.

If your credit utilization ratio soars, this could mean bad news for your credit score. And if you’re unable to make timely debt payments each month, your payment history could suffer and damage your credit score, too. Once accounts reach 30 days past due, they could be reported as delinquent to the credit bureaus — and stay there for up to seven years.

Alternatives to debt consolidation

Not entirely sold on the idea of taking out a loan or home equity product to consolidate your debt? Here are some viable alternatives to consider.

Balance transfer credit card

You can move your debts to a balance transfer card offering a 0% APR for a set period — typically between 12 and 24 months. The card usually comes with a transfer fee of 3% to 5% of the amount being transferred. Still, that’s less interest than you’ll pay on a standard credit card, and you can focus on paying down the balance without accruing additional interest each month.

Debt management plan

Credit counseling agencies can work with your creditors to create a more manageable payment plan for you. This might include reduced monthly payments, fee waivers and lower interest rates. In most instances, creditors close your old accounts once you’ve agreed to a debt management plan, so you can no longer use them while you pay back what you owe. Keep in mind that credit history length makes up 15% of your credit score so you might actually see your credit score fall with this option at first.

Debt settlement

Debt settlement companies negotiate with creditors to settle debt balances for less than what’s owed. This approach is risky as there are no guarantees creditors will accept settlement offers and late payments will continue to negatively impact your credit score as long as the outstanding balances remain. Even if your old debts are successfully settled, creditors will report them as “settled for less than what’s owed.”

Bankruptcy

If you’ve exhausted all your options, bankruptcy may come to mind. But before filing, consult a bankruptcy attorney. This is a serious decision that shouldn’t be taken lightly, as it could have negative financial consequences for several years, including a big hit to your credit.

The AP Buyline roundup

Debt consolidation can streamline repayment and help you eliminate your balances faster. It might also save you several thousands of dollars in interest. However, there are downsides, including the ability to do more damage to your credit score if you’re not disciplined and re-use the cards you pay off. Be sure to weigh the benefits and drawbacks to make sure this approach works for you.

Frequently asked questions (FAQs)

What is a disadvantage of debt consolidation?

You could risk racking up more debt than you started with and doing more damage to your financial health. Plus, some debt consolidation methods might hurt your credit score, at least initially.

How long does debt consolidation stay on your record?

When you open a new account to consolidate your debt, it should appear on your credit report within 30 days. It will stay there for up to 10 years after you close it or pay it off.

Is debt consolidation a good way to get out of debt?

Debt consolidation might be ideal if you can secure a lower interest rate than you currently pay, saving you money. It can also streamline your finances by reducing multiple creditor payments into a single one.