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Can Debt Consolidation Affect Your Credit Score?

Debt consolidation has the potential to help or hurt your credit score—depending on which method you use and how diligent you are with your repayment plan.

The strategy is considered in situations where people want to streamline the repayment of multiple high-interest debt amounts—often with the hopes of saving money and lowering their debt burden. Debt consolidation is typically used by people who have mounting debt and want to reduce the number of lenders they have to pay each month.

While eliminating or lowering your debt may help your credit score over time, debt consolidation is not typically used as a strategy to increase your credit score. It is used as a method of reducing or eliminating debt.

Can Debt Consolidation Hurt My Credit Score?

Debt consolidation has the potential to hurt your credit score in several ways, depending on which method you use. For people using a debt management plan for consolidation, it is important to fully understand your agreement with your credit counselor. It is also important to know whether you are working with a credit counselor from a not-for-profit organization, or if you are working with a for-profit debt settlement/consolidation firm.

Credit Counselors and Debt Management Plans

Credit counseling organizations are typically non-profits that exist to advise people on how to manage their money and establish budgets. Sometimes, credit counselors work with you to develop a debt management plan and can also help you make your payments.

Although debt management plans do not appear on your credit reports, credit counselors may sometimes require that you close your other credit accounts to ensure you don't spend outside of your repayment plan. Closing revolving credit accounts will increase your overall credit utilization ratio—which will impact your credit scores.

It is important to make sure that your credit counseling organization makes all payments for you on time. Credit counseling organizations typically make the agreed-upon debt payments for you each month, and so the responsibility is on them to make sure they pay each bill on time.

Payment history is the most important factor in calculating your credit score—accounting for 35% of your FICO® Score—and it is important to avoid any late payments being recorded on your credit file.

Debt Consolidation or Debt Settlement Companies

Debt Consolidation Loans

With a debt consolidation loan, it is important to first know what range your credit score falls into. For people with a "poor" credit score it may be difficult to get approved for a new loan to use for consolidation. People with "fair" to "exceptional" credit scores will have an easier time getting approved for a new loan, and will also be eligible for a lower interest rate.

Knowing your credit score before you apply for debt consolidation loans will help you choose the right loan and avoid incurring multiple hard inquiries in a short period of time.

Can Debt Consolidation Help My Credit Score?

While debt consolidation is mainly a method of lowering or eliminating mounting debt, it can also have a positive effect on your credit score. Beyond helping you reduce your number of monthly debt payments and save on interest over the life of your loans, debt consolidation can help you eliminate or drastically reduce your total debt over time.

When you consolidate revolving debt—like credit card accounts—you also will be working toward reducing your utilization ratio—one of the most important factors in calculating your credit score. Your credit utilization ratio is calculated by comparing how much available credit you have and how much you use each month. Credit utilization accounts for 30% of your credit score.

Imagine if you have one credit card with a limit of $10,000. If the balance on that card is $5,000, your credit utilization ratio is 50%. It is commonly recommended to keep your credit utilization under 30%. As you roll revolving credit debt into a debt consolidation loan, and if you keep your balances on those accounts low, this can help to reduce your credit utilization and in time help boost your credit score.

Medical Debt Consolidation

While you can consolidate many different types of existing debt, it is important to first know what the interest rate is on your current loan in order to see if debt consolidation will be helpful.

In the case of most medical debt, consolidation might not be the answer if you are hoping to save money on interest payments. Medical debt typically has a very low interest rate, and in some cases no interest.

By rolling medical debt into a debt consolidation loan or by paying for it with a low-interest credit card, you would have to pay the interest on new account—which in some cases could be more than the original rate.

In 2017, the three major credit bureaus added a policy that gives consumers a 180-day grace period to resolve outstanding medical debt before it appears as past due on their credit reports. This grace period is intended to give people extra time to settle any issues with insurance or to make a payment toward their debt.

Student Loan Debt Consolidation

Depending on what type of student loans you have, there are various consolidation options available. But it is important to be careful of restricting yourself when consolidating student loans. Depending on whether you have private or government-backed loans, consolidating can bind you to a higher monthly payment or longer term.

Federal Student Loans

Federal student loans can be consolidated through the Federal Direct Consolidation Loan Program. Your credit score is not considered for this program and borrowers that are up to date on their payments are eligible.

The main benefit of consolidating government-backed student loans is streamlining the payment process. The interest rate for your new consolidated loan will be based on what your past interest rates were and will most likely not be lower. But having one payment versus several is a helpful way to make sure that you don't miss a payment and harm your credit score in the future.

Private Student Loans

The process for consolidating private loans is slightly different than with government-backed ones. To do this, you will essentially be rolling all of your existing private student loans into a single new account and will pay that new account moving forward.

Depending on your creditworthiness, this account will have a lower interest rate which will help you save money over the life of your loan. You will also be able to make a single payment each month, taking away the hassle of worrying about late payments.

You can also roll public student loans into this new loan, however, you can not consolidate private loans with a Federal consolidation program. If you have a good credit score, you may be able to consolidate your existing student debt into a new loan with a lower interest rate. By rolling your public loans into this new account you would pay the same lower interest rate across all of your student debt.

While paying lower interest might be appealing, consolidating federal student debt into a private loan has drawbacks. Federal student loans come with certain protections—like forbearance and deferral—that you can use to pause payment of your loan if for some reason you are unable to pay. In addition to those advantages, certain federal loans are eligible for income-based repayment and loan forgiveness. Private student loans often do not have the same protections, and once a federal loan is consolidated into a private loan there features will no longer be available.

Consolidating private student loans also will require that a lender checks your credit history. Not only will this incur a hard inquiry on your credit file, but in order to get approved and get a good interest rate on your new loan, you will want to have a decent credit score.

How Can I Consolidate My Debt?

The most popular form of debt consolidation is using a newly opened low-interest loan to assume existing high-interest debt. In this scenario, you can apply for a personal loan or low-interest credit card and use the new credit to pay off their existing higher-interest debt.

Another method of debt consolidation is using a debt management plan, in which you and a credit counselor develop and agree to a repayment plan for your debt. While this method may also help you pay off your debt, credit counselors often have certain requirements, some of which might lower your credit score.

You can get your credit score and find more information about your credit file by using Experian's CreditWorks.


Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer, or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
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