How Does Debt Consolidation Affect Your Credit?

Carl Packman

18.11.2024

We all know how life can be unpredictable. It seems like yesterday we were 100% sure that we would pay off all our credits on time. Sudden change, like COVID 19 pandemic, can cause not only health problems but also financial.

We live in the most uncertain times in the last 50 years. To stay healthy become our priority, but then the economy is often overlooked. The possibility of losing a job in the time of a pandemic becomes our everyday threat. Plus, we are witnessing pretty high inflation. Keeping the balance is more stressful than before.

How in this situation do we financially manage all our previous debts? It may seem terrifying situation, but let’s look for possible solutions. Don’t worry – we have a useful proposal for you.

We will present you with debt consolidation with its various versions and its impact on a credit score. We promise that we will do our best to show you both advantages and disadvantages of debt consolidation loans to give you a clear understanding. Let’s dive into details.

What Does Debt Consolidation Do to Your Credit Score?

First, we want to give a precise definition of debt consolidation. After that, we can discuss the question of whether debt consolidation is bad for your credit. According to Forbes financial analysts, debt consolidation means taking a loan to pay off previous multiple debts.

We can imagine that if you have different credits on different credit cards, it can be hard to stay focused and make the payment on different days in a month. Debt consolidation is the solution to this kind of problem. Debt consolidation can combine all your debts, and you can pay just once monthly.

You have to return the same amount of money, but the installment is lower, and the loan period is longer. A longer credit period can be another risk for paying off your credit. Life can bring you unpredictable expenses that can cause payment delays.

On the other hand, possible money devaluation can work in your interest. In that situation, your credit rate will have a lower value compared to the time when you applied for the credit. Nevertheless, we hope that the currency will stay stable in this time of recession.

You may ask yourself, «will consolidating hurt my credit?» Because we know how a credit score can impact your financial situation, we will investigate debt consolidation risks for you. Stay with us to discover possible pitfalls that can cause lower credit scores.

• Hard Credit Checks

When you apply for a loan, credit lenders may require hard credit checks. In that situation, debt consolidation hurts your credit score. Of course, a hard credit inquiry is just a possibility, and it’s not a norm. The more your previous credit worthiness was optimal, the less possibility for your credit lenders to require a hard credit check process. Anyways, we felt responsible for mentioning to you that this obstacle is possible.

• Credit Rating Improved the Long-term

Soon after you take a debt consolidation loan, your credit score may be lower for a few points. Nevertheless, the positive thing is that your credit report will improve in the long run. Of course, this will happen only if you pay all your installments on time. Just to remind you, about 35% of your credit score is your payment history.

• You May Rush to Close Accounts

When you have a new debt consolidation loan, you may think that this is good timing to close previous accounts. Don’t rush into this decision because it’s delusional. Every account closing requires additional fees. Additionally, closing accounts may lower your credit score.

Best Way to Consolidate Debt without Hurting Credit

Are you already having trouble because of your credit score? Everybody can experience this kind of difficulty. Now you should pay attention because we will propose alternative methods that omit the consequences of debt consolidation and keep your credit score unchanged.

• Debt Management Plan (DMP)

A credit consulting agency can make your debt management plan. With this plan, you should return debt in monthly installments to the agency. The consulting agency then will pay off your debts to creditors.

• Pay Debts on Your Own

You can make your credit debts plan. The debt snowball method is a useful strategy to pay off all your debts. A simplified explanation of the debt snowball method is that you make the minimum payment and stay focused on the account with the smallest balance first. When you pay off this credit debt, it should motivate you to fully clear your debts.

• Online Payday Loans

Some payday loan offers include no credit score changes. Like LoanSolution, payday loans can be very convenient, especially if you want to apply and get credit approval online. You should be careful with online payday loans and check the interest rates in advance. Sometimes they can be disproportionally high.

• 401(k) Loan

A retirement loan, better known as a 401(k) loan, allows you to borrow 50% from your retirement account. Even though with 401 k, there is no impact on your credit score, it should be your last resort. The risky part is that it can significantly decrease your retirement.

Consolidating Debt with a Personal Loan

When you take a personal loan, you apply for a new loan. To find the best offer for a personal loan, search for the best interest rate, fees, and soft inquiry checks. Some lenders give the possibility that clients can in advance check interest rates through the application.

Consolidating Debt with a Balance Transfer Card

A balance transfer card may be a good option for you under the condition that your credit score is high. You may transfer all your credit accounts into a balance transfer card. We highly recommend that you search for a lower interest rate for an introductory period, which can even be 0% Annual percentage rates (APRs).

Nevertheless, if you decide to use a balance transfer card, you will have to be careful and look for the transfer fees. Credit card balance transfer calculator may help you in choosing the best offer.

How to Build Your Credit Score after Taking out a Debt Consolidation Loan

We will introduce to you practical steps on how to raise your credit score after your consolidation loan is approved.

• Be Punctual

Payment history has the largest percent (35%) in the FICO scoring system, so repay your credit obligations on time. With a debt consolidation loan, it will be much easier to keep in mind that you have to pay your credit installment on time.

• Change Your Spending Habits

You’ve already known that with credits, you have to have more control over your spending. You have to learn from your previous mistakes and bring some discipline into your everyday spending. Clearing credit debts has to be your priority.

• Monitor Your Credit Report

Major credit bureaus offer a free copy of your credit report annually. Use this opportunity to check all charges. Don’t hesitate to contact bureaus if you notice any error or inconsistency.

Bottom Line

We hope that this article brings some clarity about the different possibilities of using debts consolidation. We collect all the data, pros and cons, just to give you a realistic perspective about how debt consolidation loans affect credit score. To summarize, debt consolidation can be a good option if you stick up to our advice and make a decision to live up to your earnings. Feel free to share your experience with debt consolidation with us. We appreciate learning from others’ mistakes as well as from good practice.