Consolidating debt can impact your credit score in both positive and negative ways. Debt consolidation usually involves a hard inquiry and may affect your credit utilization, credit mix and account age. Combined with positive financial habits, consolidation may also improve your credit over time by simplifying payments and helping you reduce debt.
Changes to your creditworthiness depend on how you consolidate debt and manage your new payments. Let’s take a closer look at different debt consolidation methods and how they may impact your credit.
What is debt consolidation?
Debt consolidation involves rolling multiple balances into one, ideally with lower interest rate. Personal loans (sometimes called debt consolidation loans) and balance transfer credit cards are two popular methods of debt consolidation. However, it's also possible to consolidate debt in other ways, including with a home equity loan or home equity line of credit (HELOC). The right option depends on your financial situation, but when used properly, debt consolidation can give you better control of your finances and help you pay off debt more efficiently. Here's how debt consolidation can help:
- Replace multiple monthly payments with just one
- Reduce interest costs, depending on the rate and term of your loan
- Build or repair credit with timely payments
- Get a longer repayment term if necessary
Ways to consolidate debt
There are several ways to consolidate debt. Here are some popular options:
- Personal loan: You can use the funds from a personal loan for many different purposes, including paying off credit card debt. Personal loans are unsecured installment loans, which means they don’t require collateral (like a house or car), and you pay them back in fixed monthly installments, usually with a fixed interest rate.
- Balance transfer credit card: A balance transfer allows you to move credit card debt to a different credit card. Some balance transfer cards offer a low introductory APR for a set period. Borrowers can save money on interest if they can pay off their transferred balances during this period. However, you'll pay a balance transfer fee (usually a percentage of the balance transferred or a flat fee, whichever is higher). If you have any balance remaining when the promotional period ends, you’ll start accruing interest at the regular rate.
- Home equity loan or home equity line of credit (HELOC): These financial products let homeowners borrow against their home equity. A home equity loan offers access to a fixed lump sum while a HELOC is a line of credit you can withdraw from up to a limit, for a set period (called the “draw” period). Depending on your home and mortgage situation, you may enjoy higher borrowing limits and more freedom to consolidate different types of debt. But you risk losing your home if you can't repay what you've borrowed.
How debt consolidation can help your credit score
Consolidating debt can help improve your credit if managed well.
- Easier on-time payments: Having just one monthly payment can make it easier to stick to your repayment schedule. Making timely payments can improve your payment history, which significantly contributes to your overall credit score.
- Lower credit utilization: Paying down credit card balances can reduce your credit utilization ratio (the percentage of total available credit you’re using), which may boost your score over time. Moving credit card debt to a personal loan or home equity loan can also reduce your credit utilization.
- Better credit mix: Using a new type of credit or loan can help diversify your credit mix. This may improve your credit score.
How debt consolidation can hurt your credit score
On the flip side, debt consolidation can lower your credit score – usually in the short term.
- Hard inquiries: Applying for a new loan or credit card usually triggers a hard inquiry, which can lower your score by a few points temporarily. You can minimize the impact by pre-qualifying to check rates before submitting a formal application.
- Changes to credit utilization: After consolidating debt, you might choose to close your credit card to avoid the temptation to overspend. Closing accounts can lower your available credit. This can increase your credit utilization ratio. If possible, consider keeping credit accounts open to maintain a higher total credit limit.
- Reduced average age of accounts: Opening a new credit card and closing older ones can lower the average age of your accounts, which may impact your score, especially if you have a short credit history.
- Payment history: If you miss payments, this can impact your creditworthiness significantly.
While a small drop in credit is normal when you consolidate debt, the negative impact is usually temporary. Over time, if you make timely payments and maintain good financial habits, you may see an improvement in your credit score.
Keep an eye on your credit as you pay off debt
Checking your credit report from time to time can help you track your progress after debt consolidation. You can easily get a free report from each of the 3 major credit bureaus every 12 months to check your payment history and account information.
Your credit report doesn’t include your credit score, but some credit cards and issuers will provide access to your credit score for free. Checking your score regularly may help you evaluate the impact of debt consolidation on your credit.
Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.
This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.
