How Does Debt Consolidation Affect Your Credit Score?
If you’re living with debt, every financial decision you make can be worrisome. After all, if debt affects your credit significantly, won’t making efforts to eliminate your debt also affect your credit?
As you likely know, debt levels affect credit scores. But debt consolidation also impacts credit scores. And, depending on which path you choose to pursue, you could positively or negatively shape your credit score for years to come.
Here’s how different types of choices can impact your credit score.
Immediate Credit Score Impact: Hard credit pull may cause it to temporarily dip
Long-Term Credit Score Impact: None to Minimal
Debt consolidation combines multiple debts from one type of lender – such as credit cards or student loans – into one single loan. Since your original creditors are paid off, you’re now responsible for one loan that combines all of those debts together. You have just one monthly payment, interest rate, and lender.
And with a debt consolidation loan, you’re likely to pay off your debt faster thanks to a lower interest rate and better financing terms. This means debt consolidation can actually benefit your credit score. While you might have a hard inquiry on your report that drops your score a tiny amount, you’ll likely see an increase if you pay off long-standing balances.
A debt consolidation loan can also improve your credit utilization ratio, which can improve your credit score. Overall, the impact of debt consolidation is relatively minor for the long-term health of your credit.
Immediate Credit Score Impact: Moderate
Long-Term Credit Score Impact: Minimal
Debt management includes aspects of credit counseling and aspects of other types of debt programs. Typically, in a debt management program or plan, you’ll work with an agency or service that helps you repay your debt.
And the impact debt management has on your credit score depends on how the process happens. In some cases, you pay a debt management agency to repay your debt for you – and, as long as all payments are made on time, you’ll see no impact on your credit score. It can only be a positive effect over time, as more on-time payments are made and your debt decreases.
However, some debt management plans or services require you to close your credit cards once they’re paid off. That can lower your credit score. Closing accounts lowers your available credit, which decreases your credit utilization ratio. And it can also impact the age of your credit; older accounts can be a positive on credit reports.
Immediate Credit Score Impact: Usually a drop at the beginning
Long-Term Credit Score Impact: Moderate
Debt resolution is an option that can greatly reduce the amount of money you owe to lenders and creditors. This option involves debt experts or attorneys who work with your creditors. It can be a solid choice for those with late payments, delinquencies, and other financial difficulties on their credit report.
However, choosing debt resolution can have an immediate effect on your credit score. It most often negatively impacts individuals – leaving you with a lower credit score than before you started the program.
When you enter a debt resolution plan, your creditor will mark your account as “not paid in full.” This means it’s considered unpaid, as the account was already in default or collections. Additionally, because you aren’t repaying your debt, you won’t see your credit score increase from regular, on-time payments and better credit utilization.
But ultimately, getting rid of that debt can allow you to begin rebuilding your credit, increasing your score over time. So, its impact doesn’t have to be a negative forever.
Immediate Credit Score Impact: None
Long-Term Credit Score Impact: None
Credit counseling is a form of help that offers advice, assistance, and repayment guidance for anyone struggling with debt. You can work with a credit counseling agency or company, which will offer consultation and then a plan for your debt going forward.
At its most basic level, credit counseling won’t affect your credit score at all.
Credit counseling teaches you financial skills and encourages practices like repaying debt on a schedule or cutting back on your expenses, which can ultimately help your credit in the long run. However, unless your credit counseling service enrolls you in another kind of specific debt program, you won’t see any immediate or significant effect on your credit score.
Consider Your Options
No matter what type of pathway you choose, the impact that decision has on your credit score doesn’t have to be a negative. There are a number of options that can actually have little to no impact on your credit score.
And, overall, debt consolidation is a positive. Once you’ve repaid your debt in any way, you can begin working to improve your credit score with smart financial decisions. So, if debt consolidation could help lighten the burden of your current financial situation, consider pursuing one of these options now.