Can Consolidating Debt Help Your Credit Score?

Consolidating your loans and credit cards can definitely improve your credit rating—but you have to be careful.


September 22, 2017

Credit scoresYou know you need to be careful about taking on too many loans but it already happened and now you’re not sure what to do. You’re wondering if there’s anything you can do to fix your debt problems and improve your credit score. You don’t want to start missing payments and end up with bad credit or turning to payday loans and no credit check loans.

You might have heard of debt consolidation, and you’re wondering if consolidating your loans and credit cards helps your credit score. You might even have found this article while searching online for an answer to that very question!

Well, we’re here to provide those answers, as well as explain what loan consolidation means in general. Read on, and consolidate your knowledge.

What is “Debt Consolidation” Anyway?

On a basic level, debt consolidation means taking multiple loans and turning them all into one loan. (It can also work with credit cards.) There are multiple reasons you might consider debt consolidation, but on a basic level, you hope that paying off one big loan will be cheaper and more manageable than paying off all of the smaller ones.

To learn more about debt consolidation, check out our three-part blog series, Debt Consolidation 101.

So that’s the idea. But does it work out that way? And how does it impact your credit? Let’s find out!

Credit Where Credit is Due.

One of the most common ways to turn many loans into one loan is to take out a new loan big enough to pay off all the other ones entirely. Then you’ll just be paying off that new loan. And it can be a good move for your credit.

“If you take out a personal loan from your bank to pay off your credit cards, you can see your score go up as the cards get paid down,” nationally recognized credit expert Jeanne Kelly (@creditscoop) told us. “This can help you pay the credit cards faster since the interest rate is lower, but you have to be careful not to rack up more debt on those cards now that the balances are low again or paid off.”

Katie Ross, Education and Development Manager for American Consumer Credit Counseling (@TalkCentsBlog), also explained how debt consolidation loans can impact your credit:

“Consolidation can help improve your debt and credit situation. One way to consolidate credit is through a personal loan. This way you will pay off balances on multiple accounts, likely see lower interest rates, lower monthly payments, and a shorter payoff time.

“In turn, by consolidating with a personal loan, you will see a significant reduction in your credit utilization ratio, which accounts for 30 percent of your credit score. Credit utilization is the amount you owe on your credit cards versus the total amount of credit available.”

All right, so loan consolidation sounds like a great plan. Time to find the first loan consolidation place you can and get all your loans consolidated. Right?

But Tread Carefully.

Not so fast! Like with any kind of loan transaction, you’re going to want to do your research before getting your loan consolidated.

Jeanne Kelly stresses the dangers you have to watch out for: “If you sign up for a debt consolidation program, you do have to read the fine print as many do damage your credit if the accounts with your creditors get paid late and get noted as making partial payments. I see this often and most times the client never knew this would report as such. Again, be careful what you sign up for as you signed an agreement with the credit card company to pay on time.”

Natasha Rachel Smith, a personal finance expert at (@TopCashBackUSA), gave an extensive overview of the cautious approach to loan consolidation:

“If you’re in debt, only four things – simultaneously – will help you avoid greater debt: changing your attitude towards money, putting the brakes on spending, throwing more cash towards outstanding debts, and getting the interest rates of your borrowing as low as possible. It’s essential to put all four points into action to avoid greater debt; not only one, two, or three.

“Regardless of how badly you are in debt, always make the minimum repayments on your credit cards and loans. This will preserve your credit score as best as possible. If you’re not able to meet even just your minimum repayments, you are spending more than you should and have to address that immediately. Write down a budget, pause any non-essential spending, and investigate getting a second job; that’s how serious not being able to cover your minimum repayments is.

Is Debt Consolidation a Good Option for You?

Smith continues:

“When it comes to getting the interest rate of your debt as low as possible, if your credit score has been affected because you haven’t been able to keep up with your minimum repayments in the past, you won’t be eligible to move balances to new credit cards that offer dirt-cheap introductory interest rates. Therefore, your call to action is to try to negotiate with your current lenders. See if they will lower their interest rates. If they won’t, look into how much the interest rate of a balance or money transfer and its fee would be with your existing cards to switch debt around.

“If that avenue doesn’t prove fruitful, possibly because you don’t have enough credit available or your providers aren’t offering you a lower interest rate for balance or money transfers, consolidating your borrowing to be with one provider might be something worth considering. Before you commit to the idea, call each of your existing lenders and write down the interest rate you’re paying for each debt. If you have personal loans, find out if there’s an early repayment charge attached to your agreements.

“If the interest rate is five percent or less, put that debt to one side and continue chipping away at it. If the loan has an early repayment charge, put that debt to one side and continue to repay it.

“For all debts that are charged more than five percent in interest costs, as a last resort for those with a very poor credit score, it could be worth considering combining them to be paid off with a reputable loan provider. It’s vital to find a loan provider that will lend to you with a poor credit score but that also doesn’t charge an extortionate rate of interest or makes you agree to a lengthy term or unfair penalties if you accidentally miss a repayment. Read customer reviews online to guide your decision.

“Sadly, it’s likely that the interest rate will cost much more than your existing interest rates, but it’s important to get to a point where you’re able to afford your minimum repayments again; for the benefit of trying to rebuild your credit score to aid your future financial worthiness. Check whether you can pay more than the set repayment amount each month without a penalty. Only take this consolidation route if you are confident you can remain disciplined and change your spending habits once you’ve combined the applicable debts.

“Never, ever switch debt simply to have it with one lender because you think it makes it more manageable; that’s a falsehood and will cost you so much more in the long-run. That attitude will lead you into accruing further debt, snowballing additional borrowing on top of the debt you’ve already consolidated, bringing you back to square one.”

If you already have not-so-great credit—and have taken out the bad credit loans to match—then you are going to want to think long and hard before pursuing debt consolidation. Lower credit scores mean higher interest rates, which means that finding a consolidation loan with a lower rate (and qualifying for it) might just not be in the cards.

But don’t let that get you discouraged. Follow all of this advice, and you should be able to figure out if loan consolidation is a good option for you.