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Debt Consolidation: Does It Hurt Your Credit?

Key Takeaways:

  • Debt consolidation is the process of taking out a new loan to pay off multiple existing debts.
  • Debt consolidation will lower your credit utilization ratio.
  • Debt consolidation can help you pay off your debts faster.
  • With careful planning and execution, consolidation can help you become debt-free without hurting your credit score.

Debt consolidation is a popular way to manage debt, but does it actually help or hurt your credit score?

Debt consolidation can have both positive and negative effects on your credit.

If you consolidate your debt with a personal loan, you may actually see an improvement in your credit score. However, if you use a balance transfer credit card to consolidate your debt, your credit score may take a hit. 

We’ll explore the answer to this question in more detail and provide some tips on how to make debt consolidation work for you.

What Is Debt Consolidation?

Debt consolidation is the process of taking out a new loan to pay off multiple existing debts. This can be an effective way to reduce your overall monthly payments, and the total interest you are paying on your outstanding debt.

According to Bankrate, 38% of consumers stated debt consolidation was the reason they applied for a loan in the first quarter of this year.

However, it is important to remember that debt consolidation is not a magic solution to your financial problems, and it can actually have a negative impact on your credit score if not done carefully.

If you are considering debt consolidation, it is important to weigh all of the potential pros and cons before making any decisions.

One key factor to consider is whether or not you will be able to qualify for a low interest rate on your new loan. If you have good credit, you could find a loan with a relatively low interest rate that can save you money over time.

However, if you have poor credit, you may end up with a high-interest loan that could actually end up costing you more in the long run.

Another factor to consider is how consolidating your debt will impact your credit utilization ratio – this is the percentage of your available credit that you are using at any given time.

Consolidating your debt can help lower your credit utilization ratio, which can be helpful in boosting your credit score over time.

With the average American having more than $90,000 in debt according to a 2021 CNBC report, it’s not surprising that debt consolidation loans have become a popular choice among consumers feeling the mounting pressure.

However, if done poorly, consolidating your debt can actually lead to a higher credit utilization ratio, which can have the opposite effect and hurt your credit score instead.

Does Debt Consolidation Hurt Your Credit?

Debt consolidation can have both positive and negative effects on your credit.

On the positive side, debt consolidation can help you get a lower interest rate on your debts, which can save you money over time. It can also help you pay off your debts faster, which can improve your credit score.

On the negative side, debt consolidation can lead to more missed payments and a higher overall debt balance, which can hurt your credit score.

The Pros and Cons of Debt Consolidation

When you’re struggling with debt, the idea of consolidating your loans into one lower monthly payment can be very appealing.

But does debt consolidation hurt your credit?

There are both pros and cons to consider when deciding whether or not to consolidate your debt. On the plus side, consolidating your debt can help you get a lower interest rate and lower monthly payments.

It can also help you pay off your debt faster.

On the downside, however, consolidating your debt can also lead to an increase in your overall debt balance, and it may take longer to pay off your debt if you extend the term of your loan.

    The Cons

  • Can increase your overal debt balance

  • May take longer to pay off your debt if you extend the loan term

  • May have added costs

  • May encourage you to increase spending

Ultimately, the decision of whether or not to consolidate your debt should come down to what’s best for your individual situation.

If you’re thinking about consolidating your debts, it’s important to understand how it will affect your credit score. Here are some things to keep in mind:

Debt consolidation will lower your credit utilization ratio. One of the biggest factors that affects your credit score is your credit utilization ratio.

This is the amount of debt you have compared to the amount of credit you have available. The lower your ratio, the better it is for your credit score.

Debt consolidation can help lower your ratio by combining all of your debts into one loan with a lower interest rate. This will reduce the amount of interest you’re paying, which will in turn lower your Credit Utilization Ratio.

Debt consolidation can help you pay off your debts faster. If you can get a lower interest rate, you can pay off your debts much faster than if you were making minimum payments on each individual loan.

This is because more of each payment will go towards the principal balance instead of being wasted on interest charges.

Paying off your debts quickly is one of the best things you can do for your credit.

How To Consolidate Your Debt

If you’re struggling to make ends meet because of high interest debt, you may be considering debt consolidation. This is when you roll multiple debts into one loan with a lower interest rate.

While debt consolidation can be a great way to save money and become debt-free faster, you need to be aware that it can also hurt your credit score.

When you consolidate your debt, you’re essentially taking out a new loan. This means that your credit utilization ratio (how much of your available credit you’re using) will increase.

If you’re not careful, this could lead to a decrease in your credit score.

To avoid this, make sure that you don’t consolidate more debt than you can handle. Keep your payments manageable and don’t let your balances get too high.

With careful planning and execution, consolidation can help you become debt-free without hurting your credit score.

How Long After Debt Consolidation Does Your Credit Go Up?

It depends. If you consolidate your debts responsibly, your credit score could start to improve within a few months. However, if you continue to miss payments or rack up more debt, your score could drop again.

If you consolidate a large amount of debt and have a history of late payments, it could take several years for your score to recover.

However, if you consolidate a smaller amount of debt and have always made your payments on time, your credit could start to improve within a few months.

Is Debt Consolidation a Good Way To Get Out of Debt?

If you have a lot of debt, especially debt like credit cards that have high interest rates, debt consolidation can be a good idea.

This is because you could negotiate a lower interest rate and better loan terms that can help you reduce your payments and get your debt paid faster.

Alternatives To Debt Consolidation

Create a Budget

There are a few alternatives to debt consolidation that can help you get your finances back on track. One option is to create a budget and stick to it.

This will help you get a handle on your spending and make sure you are only using credit for necessary purchases.

Work with a Professional

Another alternative is to work with a financial planner or credit counselor.

These professionals can help you develop a plan to pay down your debt and improve your credit score.

Conclusion

Debt consolidation may not be the right solution for everyone, but it is worth considering if you want to reduce your monthly payments and simplify your financial life.

Ultimately, whether or not debt consolidation hurts your credit depends on how you manage your new consolidated debt payments.

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Lorien is the Country Manager for Financer US and has a strong background in finance and digital marketing. She is a fintech enthusiast and a lover of all things digital.

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Last Updated: November 28, 2022

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