How debt consolidation affects your credit

A debt consolidation loan could be the right way to forge a debt-free path forward. This financial decision will likely impact your credit, and the fact that you’re learning more about it first is a smart move on your part. Nobody is born a credit expert, and credit isn’t a typical subject in most schools, either. Self-education is often the only option.

Every path out of debt has its pros and cons. After you learn how debt consolidation affects your credit, you’ll be able to decide if it’s the best path for you.

Achieve isn't a credit repair organization and doesn't provide or offer services or advice to repair, modify, or improve your credit. 

What happens to your credit score when you get a debt consolidation loan

A debt consolidation loan usually causes a small, temporary dip in your credit score. This dip is completely normal and doesn’t mean you’ve made a bad financial decision.

Lenders run a hard credit inquiry when you apply for a loan. Hard inquiries are essentially a deep dive into your credit report. The lender looks at your personal information and the financial information that’s on file for you. A hard inquiry normally impacts your credit, but not by much. Most people’s scores drop by no more than five to 10 points.

The hard inquiry affects your credit whether or not you’re approved for the loan. The credit inquiry is part of the application process, so it goes on your credit file as soon as you submit your application.

If you’re approved for a debt consolidation loan, you’ll have a new account on your credit history. New accounts can also have a minor negative impact on your credit. That’s because a small part of your score is how old your credit accounts are, including their average age. A new loan lowers the average age of your accounts.

Let’s say you have one credit card that’s 10 years old and another that’s five years old. The average age of your accounts is 7.5 years. Add a brand new loan to the mix, and the average drops to five years.

How a debt consolidation loan could help your credit over time

A debt consolidation loan could end up helping you improve your credit for a few reasons. 

You may have an easier time staying on top of your bills, since debt consolidation could leave you with fewer monthly debt payments. If a debt consolidation loan helps you make payments on time, that’s a huge plus, because your payment history is the most important part of your credit.

If you didn’t have any loans before, getting one is good for your credit mix. As surprising as it might sound, it’s considered better for your credit score if you have credit cards and loans, not just one of the two. The idea is that you’re demonstrating the ability to manage different types of credit. Just by getting a loan, your credit score could get a bump up.

Debt consolidation could also be good for your credit utilization. Credit utilization is how much of the available credit you’re using on your credit cards. If you’re close to your credit limits, your utilization is high, which could damage your credit.

Paying off your credit cards with a debt consolidation loan sends your utilization down. Your credit score could rise if you avoid taking on more credit card debt.

How to protect your credit when you have a consolidation loan

Following a few important rules can keep your credit safe after consolidating your debt.

Always make your loan payments on time. You might want to use the lender’s auto-pay feature—just make sure you keep enough money in the bank to cover the payment amount. Another option is to set up a monthly reminder of the payment due date. Paying on time is good for your payment history. Also, you’ll get your loan repaid on schedule: a definite win-win.

Along with making on-time payments, avoid taking on new debt. More debt can affect your credit, and you’ll also have more to pay back. If you think you’ll be tempted to use your credit cards, consider closing them. If getting rid of your credit cards puts you in the best position to succeed financially, then you’ll be making a smart move.

What’s next?

You now know exactly how debt consolidation affects your credit. You’ve also learned about the pros and cons of debt consolidation and how it could benefit your finances in the long run. If you’re thinking of consolidating debt, here are the next steps to take:

• Check your credit report and your credit score. You can get your credit report for free online at AnnualCreditReport.com, and several online tools provide your credit score free of charge. Use this information to get a grasp on your current credit situation.

• Plan your monthly budget. Spend some time going over your bank statements and credit card bills. Decide which expenses you’ll keep and which ones you can cut.

• Review your plan to avoid new credit card debt. The most effective option is to close your credit cards. You don’t need to go that route, but it’s best to have a plan for avoiding debt after consolidation.

• Compare rates. Many lenders let you check potential loan rates with just a soft credit inquiry, which doesn’t affect your credit score. You can normally find out on a lender’s website if it only runs a soft credit inquiry when you check your loan rate. Look for “check your rate with no impact to your credit score” or similar language.

If you’d like more help, you can also get personalized assistance. Talk to a debt expert to learn about your options for getting free of debt.