How does debt consolidation impact and affect your credit score?

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• Debt consolidation may hurt your credit in the short-term, but will better for your long-term credit. 
• Debt consolidation usually consists of opening a new line of credit, which will trigger a hard inquiry on your credit.
• In the long term, debt consolidation will help you pay down debt and avoid missed payments.

Many people have to keep track of multiple monthly debt payments between several credit cards, student loans, and other loans. Keeping track of due dates can be difficult, and some debts may have higher interest rates than others. Consolidation is one debt relief option that can simplify your monthly payments and save money.

Consolidating your debt will also impact your credit score, depending on how you consolidate.  

What is debt consolidation? 

Debt consolidation is the process of combining numerous debts into one large debt, simplifying your monthly payments. According to  Sophie Raseman, head of financial solutions at Brightside, debt consolidation can take various forms, such as opening a balance transfer credit card, taking out an installment loan or home equity line of credit (HELOC) to pay off other debt, or paying off one student loan with another student loan. 

While the overall amount of debt does not change when someone consolidates their debt, it can still help borrowers in two significant ways. First, Michael Hammelburger, a certified financial advisor with the Bottom Line Group, says that the best consolidation loans will typically have a lower interest rate than their current rates, which can save a significant amount of money over time. Second, consolidating debt simplifies the repayment process since there is only one monthly payment to keep track of.

Consolidating debt can take anywhere from a few weeks to a few months. How long the process takes depends on several factors including the total amount of debt, the method selected to consolidate, and the procedures followed by the lender, Hammelburger says.

Simplifying debt and saving money sounds like a good idea, but it might not make sense for some people. Hammelburger says, "it is absolutely necessary to conduct research and acquire a thorough understanding of the conditions" before moving forward with the process. He recommends looking closely at interest rates, fees, and potential risks, associated with debt consolidation before taking out a loan to consolidate your debt.

Understanding the impact debt consolidation can have on your credit score is also important.  

See our picks for the best debt consolidation loans »

Does debt consolidation hurt your credit?

Debt consolidation will hurt your credit when you start your debt consolidation. That said, debt consolidation should help your credit in the long run if you make your payments on time.

There are three main ways debt consolidation can hurt your credit score.

Hard inquiries

Since debt consolidation involves taking out a new line of credit, be it a consolidation loan or balance transfer credit card, financial institutions will likely conduct a hard inquiry into your credit history to see if you qualify. Hard inquiries can negatively impact credit scores, although the impact is likely to be "slight," says Hammelburger.

Average age of credit accounts

Another factor in how credit scores are calculated is the average age of your credit accounts. Because you're opening a new line of credit, your average age of credit accounts will decrease, lowering your credit score.

Closed accounts

Many people close accounts that have been paid off in the process of consolidating debt. This results in a smaller number of open accounts and less available credit. Both of these factors can lower your score, says Renauld Smith, executive director of IAPDA Certification, a non-profit organization that certifies and accredits debt settlement companies. 

How can debt consolidation raise your credit score?

While you'll experience an initial decrease in your credit score, debt consolidation can eventually help you raise your credit score. If you make all your payments on time, you'll finish your debt consolidation in a better place than where you started.

Positive payment history

First, if a debtor makes all of their payments for the consolidated loan on time, their credit score is likely to increase, Hammelburger says. The change may be gradual, but your credit score will eventually reflect a history of on-time payments, resulting in a higher credit score. 

Having one large debt instead of several small debts will also decrease the chance that you accidentally miss a payment, which would result in a delinquency on your credit report. Delinquencies stay on your credit report for seven years and will drop your credit score significantly.

Lower credit utilization ratio

Depending on how you restructure your loans, consolidating debt may result in lower credit utilization, which will cause your credit score to rise. One way this happens is if you pay off credit card debt with an installment loan but keep the credit cards open without using them, Raseman explains. Having a lower debt-to-credit utilization ratio can help your credit score. 

However, Raseman cautions that this approach often comes with "constant temptation" to use your credit cards, so removing that temptation is important. She recommends removing unused credit cards from your digital wallet, deleting them from merchant sites, and stowing them away. Note that some credit cards require periodic usage to remain open.

As important as credit scores are, Smith urges those consolidating debt to shift their focus to their personal financial goals. "Unless we prioritize sound, intentional money management, a good credit score is nearly meaningless," he says. 

Debt consolidation and credit scores frequently asked questions

How long will a debt consolidation stay on your credit report?

A line of credit used to consolidate debt will be reported like any other line of credit. These accounts, closed in good standing, will remain on your account for 10 years after you close your account, positively affecting your credit score. 

What are the disadvantages of debt consolidation?

One disadvantage of debt consolidation is that you'll need a good credit score to qualify for favorable interest rates. If your credit score is bad, any rates you qualify for likely won't be lower than the interest rates on your current loans.