Debt Consolidation: Does It Help or Hurt Your Credit?

debt consolidation

By Janet Berry-Johnson, CPA

When you’re trying to get out of debt, dealing with multiple accounts and due dates can be frustrating. Just when you think you’re getting ahead, you accidentally miss a payment, incur a late fee, and feel like you’ll never make it out.

In that case, consolidating your debt might be the answer. By rolling all of your outstanding debt payments into one, consolidating debt can simplify your financial life and perhaps even lower your overall cost of debt. But while debt consolidation provides some real benefits, it can also come with pitfalls if you aren’t careful.

Let’s dig into how debt consolidation can affect your credit score.

What is debt consolidation?

Debt consolidation is the process of combining several debts from credit cards, high-interest loans, and other bills into one monthly payment. In the process, you may be able to lower your interest rate–helping you save money on interest and pay down debt faster.

It’s typically used for unsecured debt since unsecured debt – such as credit card debt – usually carries higher interest rates than secured debts like mortgages and auto loans. According to a survey from U.S. News & World Report, the most common types of debt to be consolidated include:

  • Credit cards: 55.8%
  • Personal loans: 23.0%
  • Student loans: 15.8%
  • Medical bills: 13.5%
  • Payday loans: 8.2%
  • Other debts: 11.6%
There are two types of debt consolidation:

1 - Debt consolidation with a personal loan

The first type of debt consolidation involves applying for a personal loan and using the money from that loan to pay off credit card debt and other high-interest debt. If the interest rate on the new loan is lower than the rates you’re currently paying, you can pay down debt faster because more of your monthly payment is going toward the loan’s principal.

2 - Debt consolidation with a debt settlement company

Another method of debt consolidation involves working with a company to create a debt management plan. Under these plans, a debt settlement company negotiates with creditors to reduce the balances on your debts. Rather than pay your creditors directly, you make one monthly payment to the debt settlement company, and the company makes payments to creditors on your behalf.

How does debt consolidation affect your credit?

How debt consolidation affects your credit depends on the method you choose. Keep in mind that taking out a debt consolidation loan may initially lower your credit score.

When you apply for the loan, the lender performs a credit check to gauge your creditworthiness. That credit check appears as a hard inquiry on your credit report. One hard inquiry could initially take up to five points off your credit score.

However, over the long term, a debt consolidation loan can actually improve your credit score. According to Experian, this happens for several reasons:

  • Lower credit utilization. Installment loans are not considered in calculating your credit utilization ratio, a key component of the credit scoring formula. When you pay off credit cards with a personal loan and leave the credit accounts open, you lower your credit utilization ratio, which increases your credit score.
  • Variety of credit types. Another component of the credit scoring formula is your credit mix. Having a combination of revolving accounts and installment loans is better than using only one type of account. Adding a personal loan to the mix can improve your credit score.
  • Payment history. One of the most important factors in the credit scoring formula is a history of on-time payments. As long as you make monthly payments on the personal loan on time and in full, consolidating debts with a personal loan will help your credit score.
A debt management plan is another story. When your account is included in this type of program, the creditor closes your account, causing your credit utilization rate to increase which can lower your credit score.

Also, when the debt consolidation company negotiates a reduced balance on your debt, your creditors will report your account as “settled for less than the full balance” to the credit reporting agencies. Settled accounts impact your credit scores negatively and remain on your credit report for seven years.

For the preceding reasons, a debt management plan is usually only a good choice if you are deeply in debt and have a history of missed payments or defaulted accounts.

Can I get a debt consolidation loan with bad credit?

Getting a debt consolidation loan with bad credit is no easy task. According to U.S. News & World Report, most reputable debt consolidation loan companies require a minimum credit score of 580 or higher.

If you can’t qualify for a debt consolidation loan with decent terms, you might consider these alternatives.

  • Credit card with a zero percent balance transfer offer. Some credit card companies offer a zero percent APR on balance transfers for anywhere from six to 21 months. If you go this route, watch out for fees, which can potentially offset the financial benefits of zero percent interest. Make a plan to pay off the full balance before the introductory period expires and avoid new charges during that time.
  • Credit counseling service. Some non-profit organizations offer counseling to help consumers manage their money and debt. A credit counselor may help you set up a plan to repay your debts without settling for less than the balance owed. You can find a list of reputable credit counseling services through the U.S. Department of Justice.
  • Home equity loan or cash-out refinance. If you own a home and have considerable equity, a home equity loan or cash-out refinance allows you to tap your home’s equity to consolidate debts. These loans are usually lower interest because they’re secured by your home. However, if you fall behind on payments, your risk losing your home.

Bottom line

Dealing with high-interest credit card balances on multiple accounts and various due dates can make it tough to pay your bills and save money.

Debt consolidation may hurt your credit score in the short-term, but if you make regular, on-time payments, pay off the loan quickly and avoid wracking up new debts in the meantime, your credit score will recover and may even improve.

About the Author

Janet Berry-Johnson is a Certified Public Accountant and personal finance writer. Her work has appeared in numerous publications, including CreditKarma and Forbes.

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Written on February 26, 2019
Self is a venture-backed startup that helps people build credit and savings. Comments? Questions? Send us a note at

Disclaimer: Self is not providing financial advice. The content presented does not reflect the view of the Issuing Banks and is presented for general education and informational purposes only. Please consult with a qualified professional for financial advice.

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