Does Debt Consolidation Affect Your Credit Score?

Key insights:

• Debt consolidation can simplify your payments and diversify your credit mix, factors that may positively impact your credit score over time if managed responsibly
• Popular options include personal loans, balance transfer credit cards and home equity loans or lines of credit, each with unique benefits and considerations
• Maintaining timely payments and monitoring your credit report are crucial during debt consolidation

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 credit score 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 score.

What is debt consolidation?

Debt consolidation involves rolling multiple balances into one, ideally at a lower interest rate. Personal loans for paying off multiple debts (also 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, such as with a home equity loan or a home equity line of credit (HELOC). The right option depends on your financial situation. When used properly, debt consolidation can help to 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 installment loans and are generally unsecured, meaning they don’t require collateral (like a house or car). You can pay these loans 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 revolving 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. One drawback, however, is that 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 score if managed well. Some benefits include:

• Easier on-time payments: Having just one monthly payment can help 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 credit 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, which may improve your credit score.

How debt consolidation can hurt your credit score

On the other hand, debt consolidation may lower your credit score, often temporarily. The negative impact is usually a result of the following:

• 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 your 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, which can increase your credit utilization ratio.
• 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 credit score, especially if you have a short credit history.
• Payment history: If you miss payments, it can significantly impact your credit score.

While a small drop in credit score 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.

How to monitor your credit as you pay off debt

Checking your credit report regularly 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 week 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 credit score regularly may help you evaluate the impact of debt consolidation on your credit score.

Consolidate debt with a Citi^® Personal Loan

When managed responsibly, debt consolidation can simplify monthly payments and help you reach your financial goals. If combining multiple debts into 1 is the easiest strategy for you, a debt consolidation loan might make sense.

Citi offers flexible, fee-free personal loans to qualified applicants. Additionally, existing Citi customers with an eligible deposit account or credit card may qualify for up to $50,000 and receive funds within 2 business days. If a debt consolidation loan sounds right for you, 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.