Debt Consolidation
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LendingTree is compensated by companies on this site and this compensation may impact how and where offers appear on this site (such as the order). LendingTree does not include all lenders, savings products, or loan options available in the marketplace.

How Debt Consolidation Affects Your Credit Score

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Content was accurate at the time of publication.

Debt consolidation helps you pay off existing debt with a new loan or line of credit, preferably one with more favorable terms like a lower interest rate. Under the right conditions, debt consolidation can help lighten a financial load. But one factor often gets overlooked: Debt consolidations can hurt or help your credit.

Here’s what happens to your credit when you consolidate debt. And if you’re worried about taking out a new loan or line of credit, you’ll find two alternatives as well.

How debt consolidation can hurt and help your credit

How does debt consolidation hurt your credit?

Debt consolidation often involves taking out a new loan or credit card to pay off existing debt. In general, taking on any kind of new debt to help pay off old ones will lower your credit score, even if temporarily.

These approaches in particular require a hard credit check during the formal application process, which hurts your credit score. And while the effect is often short-lived, a hard credit check might leave a larger credit ding if you have other large debts or a history of late payments.

Here are examples of how paying off debt can hurt your credit score:

  • Triggering a hard credit inquiry: Applying for a new loan or line or credit leads to a temporary dip in your credit score because lenders do a hard credit inquiry during the formal approval process. Applying for one type of loan will affect your score less than applying for different forms of financial help at once. On average, hard inquiries will take a few points off your score. This dip will likely disappear as you consolidate debt and rebuild credit. You can expect hard inquiries to stay on your report for about two years.
  • Closing out credit cards: It may be tempting to close credit card accounts after paying them off, but this lowers your total available credit and reduces the length of your credit history. All affect your credit score. Consider leaving your oldest accounts open, as well as the ones with the largest credit limits.
  • Using a debt management plan: A nonprofit credit counseling agency may be able to create a streamlined plan to help you pay back debt. This often means closing your credit cards, which can cause your score to dip. Expect it to climb as debts get paid off on time, however.
  • Making late payments: Your debt payment history accounts for 35% of your credit score, so it affects your credit more than any other factor. Keep making timely payments on your accounts to prevent your score from dropping.

How does debt consolidation help your credit?

Debt consolidation can boost your credit in huge ways. For example, using a personal loan or home equity loan to pay off credit card debt means you might be able to pay off your balance faster and save on interest payments. That’s because both loan types typically come with lower interest rates – especially if you have excellent credit.

Here’s more on how debt consolidation may help your credit:

  • Improves your credit history: With debt consolidation strategies you’re more likely to make timely payments and in turn raise your credit score. Paying more than the minimum you owe every month might boost your score further.
  • Reduces your credit utilization ratio: Paying off credit card debts with a consolidation loan frees up your available credit and reduces your credit utilization ratio. This number compares how much debt you carry to your credit limit; ideally you want to keep it at or below 30%.
  • Improves your credit mix: If you only carry a few types of debt, diversifying the mix with a consolidation loan might actually increase your credit score. That’s because lenders see you as a responsible borrower who can successfully juggle different kinds of debt.

Consolidating with a debt consolidation loan

Debt consolidation loans are personal loans used to roll multiple debts under a new loan, often with better terms. This can include a lower interest rate and/or longer or shorter repayment terms. Unlike credit cards, a personal loan offers a fixed interest rate and fixed repayment timeline, making it easier to manage debt.

The annual percentage rate (APR) for personal loans typically varies between 5% and 36%, compared to 15% to 23% for credit cards. However, with a personal loan, you’ll likely see better rates and loan terms with a credit score of at least 660. If your credit score is below 580, you may still qualify for debt consolidation, but your APR might be much higher than the rates on your current debts.

How to apply for debt consolidation

  • Research lenders: Consider the types of loans and interest rates lenders may offer you. They typically look at factors like credit score, income, current debts and debt-to-income (DTI) ratio. To find personalized loan offers based on your credit history without affecting your credit score, check out LendingTree’s personal loan marketplace.
  • Apply for prequalification: Prequalify for a loan by submitting details to lenders like your income, debts and credit history. They’ll conduct a soft credit inquiry – which doesn’t affect your credit score – to determine whether you’d likely qualify, and for what terms. Prequalification doesn’t guarantee loan approval but is a great way to research terms you could see with a lender.
  • Compare offers: Compare loan offers by looking at each offer’s APR and other terms, as well as fees. Personal loans often come with origination fees that range from 1% to 8% of the amount owed, and some also come with late payment fees and prepayment penalties.
  • Choose a lender and submit a formal application: Once you’ve picked a lender, gather necessary documents, like proof of income, income and other forms of debts. Before they formally approve you, lenders will do a hard credit check.
  • Start paying off existing debt: If you’re approved, your lender will deposit the entire loan amount into your bank account so you can begin paying off your debts. Stick to your monthly payments to avoid late payments (and fees) that might damage your credit.

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Consolidating with a balance transfer card

A balance transfer credit card can help shave debt by transferring one or more credit card balances to another card with a lower interest rate. Many cards also come with a special introductory period where you pay zero interest for 15 months or longer.

If you pick a balance transfer card with a zero-interest promotion period, make sure you can pay off your entire balance before the period ends. Otherwise, you could end up paying interest on your balance from the original purchase date.

Your credit score may ultimately determine whether a balance transfer card is your best debt-consolidation tool – or whether you’re better off with one of the options we’ll discuss later. If your credit score is over 740, you’re more likely to receive your best interest rate, a longer-than-average introductory period and no balance transfer fee. If your score is in the 580 to 669 range, you’ll have difficulty finding attractive credit offers, and they’ll probably have shorter introductory periods.

How to apply for a balance transfer card

  • Research credit card issuers: Check your current card balances and interest rates to find a balance transfer card with a lower interest rate and a credit limit large enough for your transfer amount. You can search for up-to-date credit card offers on LendingTree.
  • Apply for prequalification: Once you find cards that might work, apply for prequalification online. Each card issuer will do a soft credit inquiry to determine whether you meet their criteria by checking basic information like proof of identity.
  • Compare offers and choose your card: Make sure you fully understand the terms and conditions of each offer. Balance transfer fees, for example, can add up. While some credit card issuers charge no fee, many change between 3% and 5% of the total balance transfer amount.
  • Apply for a card: Complete a formal application and send it to a card issuer. Before approving you, the card company will perform a hard credit inquiry to check your income, debts and whether you have a history of on-time payments or bankruptcies.
  • Start the balance transfer: Once your application has been approved, you can transfer existing credit balances into your new account online or by working with your creditor by phone. Avoid late fees by making payments on your current cards until your issuer confirms that all transfers have gone through.
  • Start making payments: After your balance transfer is complete, start paying down debt on your new card. Keep your old cards open to avoid damaging your credit score.

Other ways to consolidate debt

Home equity loans

Homeowners may be able to use the equity in their home to obtain a home equity loan or a home equity line of credit (HELOC) to help consolidate debt. With a home equity loan, you’ll get your money in one lump sum that you pay back in predictable, fixed payments every month. Like a credit card, HELOCs give you access to cash when you need it, but they also come with adjustable interest rates.

In both cases, you’ll need strong credit, and the amount you can borrow depends on how much equity you have in your home.

Both options generally carry lower interest rates than what you’d expect with unsecured personal loans and credit cards because they’re backed by your home. If you default on a home equity loan, you could lose it. A HELOC could also damage your credit if you were to overspend and couldn’t repay what you owed plus interest after the initial draw period (often 10 years) was over.

401(k) loans

A 401(k) loan lets you borrow from your employer-sponsored retirement savings plan – if your employer offers this option.

You can use this loan to pay off debts, often at a low interest rate, and you won’t need a credit score check to qualify. However, if you don’t repay the loan on time – usually within five years – or don’t repay it after leaving your job, you may owe taxes on it.

The good news is 401(k) loans won’t show up as debts in your credit history, and credit bureaus won’t be notified if you default on it. Here’s the caveat: By borrowing money from a 401(k) – where money generally earns compounded interest over a long period of time – you risk losing major savings in the future.

Does debt consolidation ruin your credit?

In short, debt consolidation will only hurt your credit if you let it. Debt consolidation doesn’t resolve debt on its own, so watch your spending habits. For example, transferring credit card debt to a personal loan to free up existing balances might tempt you to spend all over again. In the end, setting a solid budget and following money management tips may be your best bets for leaving debt behind once and for all.