Does debt consolidation hurt your credit scores?

Written by: Eric Rosenberg
• Edited by:Liza Carrasquillo, Editor, Credit Cards
• Updated •9 min read
This date may not reflect recent changes in individual terms.
Portrait of man sitting on his balcony using smartphone and digital tabletImage: Portrait of man sitting on his balcony using smartphone and digital tablet

In a Nutshell

Debt consolidation combines multiple debt balances into one new loan. It’s likely to raise your credit scores in the long run if you use it to pay off debt, but you might see a fall in your scores at first. As long as you make payments on time and don’t rack up more debt, however, they should recover.
Editorial Note: Intuit Credit Karma receives compensation from third-party advertisers, but that doesn’t affect our editors’ opinions. Our third-party advertisers don’t review, approve or endorse our editorial content. Information about financial products not offered on Credit Karma is collected independently. Our content is accurate to the best of our knowledge when posted.

Debt consolidation can lower your monthly payment and improve your credit, but only if you stick to a plan to pay down your debt.

If managed carefully, debt consolidation is often beneficial in the long run, both for your credit scores and your overall financial health. But if you continue to borrow more after consolidating your existing debt, your scores may not improve and you may end up in a worse financial position.

We’ll review how debt consolidation works, the credit score factors to consider when you’re consolidating debt and potential alternatives.

If you’re wondering where your credit stands, you can check your VantageScore 3.0 credit scores from TransUnion and Equifax for free on Credit Karma. That will help give you a baseline for progress.

What is debt consolidation and how does it work?

Debt consolidation allows you to combine several outstanding debts into one loan — or onto one balance transfer credit card. So instead of juggling multiple payments from different accounts each month, you only need to manage one payment.

Debt consolidation loans and balance transfer cards typically come with relatively low interest rates or low introductory APR offers, which can save you money on interest each month. But lenders may charge fees to consolidate, which will offset some of your savings. Because the goal is to save money, debt consolidation is typically best for consolidating high-interest debt, like debt from credit cards, where the lower rate can make up for any fees.

How debt consolidation affects credit scores?

You have many different credit scores, and debt consolidation may affect each one differently. FICO and VantageScore, two of the most popular scoring brands, emphasize the importance of many factors similarly.

Let’s look at the factors that influence the VantageScore 3.0 credit scoring model specifically, as well as how they could be impacted during your debt consolidation process:

  • Payment history (40%) — Your payment history is the biggest factor in your credit scores. As you pay off your debt consolidation loan or balance transfer card on time each month, you’ll grow a positive payment history. Over time, you’ll likely see your credit scores slowly rise.
  • Depth of credit (21%) — This refers to the age of your accounts and the mix of credit types you have. Opening a new account will lower your average account age, which might lower your scores slightly at first.
  • Credit utilization (20%) — Credit utilization  measures of how much of your available revolving credit you’re using. If you use a personal loan to pay off credit cards, your utilization will drop significantly because you are moving the debt off your revolving accounts. If you open a balance transfer card, your utilization may drop because you are increasing your total credit limit. Both are beneficial to your score.
  • Balances (11%) — This factor looks at all current and delinquent balances on your accounts. As you pay down your debt, your balances will fall, which can have a positive impact on your scores.
  • Recent credit (5%) — When you apply for that personal loan or balance transfer credit card, the lender will perform a hard inquiry, which will typically lower your scores by a few points. If you open the account, it then counts as new credit, which could also lower your scores slightly. These effects are usually temporary, however.
  • Available credit (3%) — This looks at how much unused credit you have on revolving accounts. As you pay down your debt, your available credit will rise, which could have a minimal yet positive effect on your credit scores.

Is a debt consolidation loan good for your credit?

A debt consolidation loan can be good for your credit as long as you make all payments on time and avoid new debt.

This is crucial because payment history typically has the greatest impact on credit scores. Plus, paying off revolving balances can lower your credit utilization ratio, another key factor in scoring.

Although you may see a dip in your scores from the credit inquiry and new account, the impact is short-lived.

Types of debt consolidation

The basic idea of debt consolidation is to merge multiple credit or loan balances into one new loan. But, not all debt consolidation methods will be right for your situation. Depending on your credit scores and level of debt, consider one of these options:

Balance transfer credit cards

Balance transfer cards offer introductory periods when they charge low or no interest on balances that you transfer to the card within a set period of time. After that period ends, the remaining balance is subject to a new, higher APR. 

Using one of these cards can help you make faster progress toward paying off your debt.

These cards often come with balance transfer fees of 3% to 5% of each amount transferred, however, and you’ll still have to pay at least the minimum amount due on the card each month. Otherwise, you could risk losing your promotional APR offer.

Personal loans

You may be able to get a personal loan with a lower interest rate than some of your higher-interest accounts, like credit cards. If so, you can use the money from that loan to pay off one or more of your card balances.

Some lenders offer debt consolidation loans, which are types of personal loans specifically geared toward paying down multiple debts. These loans may come with limited-time promotional rates similar to those from balance transfer cards.   

If the new rate is significantly lower than your credit cards, this method can save you money when it comes to interest.

401(k) loans and other retirement account loans

You may be able to take a loan from your retirement account to consolidate and pay off debt. Just be careful to pay it back according to the retirement plan’s rules, or you may face taxes and penalties.

Also, be aware that if you leave your job, the loan may become due in full immediately.

Home equity loan or line of credit

With a home equity loan or home equity line of credit (HELOC), homeowners who’ve built up equity in their home may be able to take out a loan using their home as collateral. These loans typically offer lower interest rates than credit cards or personal loans.

But beware: If you don’t pay it back, you could lose your home.

How to consolidate your debt without hurting your credit scores

While it may not be entirely possible to avoid hurting your credit when you consolidate your debt, there are steps you can take to minimize the impact. Here are a few tips:

  • Pay your bill on time. Building up your payment history with on-time payments is one of the best ways to build your credit scores, especially if you’ve been struggling to keep up with all of the payments across your accounts.
  • Keep your old credit lines open. If you close your older credit lines, you lose that available credit limit, which can spike your credit utilization ratio and lower your score. However, closing them might still be the best move if you’re trying to avoid the temptation to spend.
  • Avoid opening new accounts.  Opening new credit accounts requires a hard credit inquiry and lowers your average credit age, which can bring your credit scores down. If you’re planning to open a debt consolidation loan or balance transfer credit card, don’t apply for other credit until you’ve paid down your debts and your scores have had time to recover.
  • Monitor your credit report regularly. Keeping an eye on your credit report is a good way to keep tabs on your accounts and make sure there aren’t any errors that could be contributing to lower scores.
  • Stick to a budget. This can help you avoid falling back into debt by spending more than you can afford to pay off.

Pros and cons of consolidating your debt

Debt consolidation can be a good financial tool if you have multiple debts that you’re struggling to balance. Here are some pros and cons to consider:

Pros of consolidating debt

  • You can save money on interest if you qualify for a lower rate.
  • You’ll combine multiple monthly payments into just one. 
  • Your credit may improve in the long run with on-time payments and a better credit utilization ratio.

Cons of consolidating debt

  • Your credit could go down in the short term because of the hard inquiry and new account opening.
  • You’ll likely have to pay balance transfer fees or loan origination fees.
  • You may not get approved for a low enough interest rate to make consolidation worth it.
  • You may owe more than what you started with if you don’t stay on top of your payments.

FAST FACTS

The best balance for your credit scores is zero

Carrying a balance does not help your credit scores, no matter what you may have read or heard elsewhere. If you use a card regularly and pay it off in full every month, it can give you the biggest credit score boost without paying a cent in interest.

ShowHide

Debt consolidation options

If you’re ready to look into personal loans or balance transfer cards to help you consolidate your debt, consider these options:

Debt consolidation alternatives

Debt consolidation isn’t the only option for paying down balances. Here are a few alternatives that may work for you:

  • Starting a debt management plan with a credit counselor: A certified credit counselor from a nonprofit credit counseling agency could create a debt management plan for you by negotiating a repayment plan with your creditors. This plan may include reducing your interest rates or lowering your monthly payments. You’d then make monthly payments to the agency, who would pay your creditors.
  • Using the avalanche method: The avalanche method saves you the most money on interest. You pay the minimum on all your accounts, then put any extra money toward the account with the highest interest rate. Once that is paid off, you take the money you were paying on that debt and apply it to the next highest interest rate.
  • Using the snowball method: Another popular option, the snowball method also requires you to pay the minimum on all of your accounts each month. After that, you pay toward the account with the lowest balance with your leftover money. Once that’s paid off, you’ll roll that money into the payments toward the account with the next lowest balance.
  • Requesting loan forbearance: You may qualify for loan forbearance if you are experiencing a financial hardship. This may temporarily suspend or reduce your payments.
  • Negotiating with creditors yourself: You can try to work with your creditors to decrease your interest rates, waive fees or extend your repayment period. 
  • Signing up for debt settlement or debt relief: Debt relief and debt settlement companies may try to negotiate with your creditors for a more favorable repayment plan or settle your debt outright for less than what you owe. But proceed with caution: These companies often charge high fees or make promises they can’t keep. Plus, there’s no guarantee that your creditors will accept the new terms, meaning you could be worse off than when you started the process.
  • Bankruptcy: This legal process can help you reorganize or eliminate your debt, but it will stay on your credit report for up to 10 years and may impact your credit score for years.

What’s next?

Consolidating your debt into a new, lower-interest loan — whether it’s a balance transfer credit card, personal loan or home equity loan — may impact your credit scores in the short-term but should be beneficial in the long term.

As you pay down your debt, consider monitoring your credit to see the changes for yourself.

Credit Karma provides free credit reports and VantageScore 3.0 credit scores from TransUnion and Equifax. Looking at these regularly can allow you to spot errors on your reports and keep track of your overall credit health while you build toward a debt-free future.

FAQs about debt consolidation

A debt consolidation loan is a personal loan designed to pay off multiple other creditors, allowing you to combine various debts into one single monthly payment. These loans typically come with fixed interest rates and set repayment terms, giving you a clear timeline for when you will be debt-free.

It is usually a good idea to consolidate credit card debt if you have high-interest debt (like credit cards charging 20% or more) and can qualify for a loan or balance transfer card with a significantly lower rate. Always do the math to ensure the interest savings outweigh any balance transfer or origination fees.

Yes, but be cautious. If you use the same card that holds your transferred balance, your new purchases may not qualify for the promotional APR. Plus, carrying a balance often eliminates the grace period on new purchases, meaning you will start accruing interest on them immediately.

If you continue to use the credit card that previously held your transferred balance, be sure to keep an eye on your spending. Otherwise, you could wind up reaccumulating debt.

About the author: Eric Rosenberg is a finance, travel and technology writer in Ventura, California. He has an MBA in finance from the University of Denver. When he’s away from the keyboard, Eric enjoys exploring the world, flying small… Read more.