Personal Finance Basics

How does debt consolidation affect your credit?

August 10th, 2023 Aug 10, 2023 • Read time: 6 min


Debt consolidation loans are a popular way for people to combine many of their debts into one loan to pay off. If current interest rates are low (be sure to check), a debt consolidation loan lets you combine your debts into a new loan with a potentially better rate. Debt consolidation not only combines many debts into a single monthly payment, but it also might save you money each month on interest if your new rate is lower. An important thing to keep in mind, however, is your credit. Most people considering debt consolidation don’t realize it can impact your credit. We’ll explain how.

Will a debt consolidation loan affect your credit?

The short answer is yes. A debt consolidation loan may hurt your credit score–but don’t worry because it can also help. The negative impact on your credit is often short-term, and your credit can definitely bounce back over the long run. It’s important to remember that even with the short-term hit on your credit score, a debt consolidation loan can also be very helpful, depending on your situation. That’s because it reduces the number of monthly payments you’re making. And you may also be able to save money on interest if you lock in a better rate.

How a debt consolidation loan can help your credit 

As we mentioned, a debt consolidation loan can help and hurt your credit. Let’s first look at how it can help.

  • Improved credit score: When you take out a debt consolidation loan, the lender pays off your existing debts, leaving you with one new loan. Credit reporting agencies will see that your debts have been paid, which can help raise your credit score since you no longer have multiple unpaid debts. 
  • Better payment history: Payment history is the biggest and most important piece of the credit score puzzle. No matter what type of loan you have, making payments on time every month will boost your credit score. Not making payments on time will hurt your credit score. It’s that simple. With a debt consolidation loan, you combine many debts into one loan–and if you make payments on time each month, your credit score can climb.

How a debt consolidation loan can hurt your credit 

Overall, debt consolidation can be helpful down the road, but it may hurt your credit score in the short term–oftentimes only for a little while. Here’s how:

  • Applying for new credit: Whenever you apply for credit, no matter what your current credit score or financial situation is, your credit will be affected. As you’re thinking about debt consolidation, remember that this is also a new form of credit for you. So when you apply for a debt consolidation loan, the lender will do a hard inquiry (credit check) on your credit. And that will lower your credit score by a few points.
  • Opening a new credit account: If you’re approved for your debt consolidation loan, congratulations! That’s great news. But remember, whenever you open a new line of credit, such as a credit card or personal loan, your credit score drops temporarily. That’s because lenders look at new credit as a risk. Remember, though, that consistent on-time payments should pull your credit score back up again.
  • Lowering your average age of credit: When you have older accounts, it shows a longer history of on-time payments, which keeps your credit score higher. However, when you open a new account, not only does the average age of all your accounts go down, but it also brings a new account without any payment history into the picture. That all combines to briefly impact your credit score.

Despite some negative hits to your credit score, the bottom line is this–if you know that you’ll be able to make all your payments on time and that a debt consolidation loan will ultimately help you pay off your debt, it could be the right choice.

The do’s and don’ts of debt consolidation for your credit

Steps to take when consolidating debt 

Despite the brief impact on your credit score, there are many ways you can use debt consolidation to your advantage and ultimately improve your credit.

  • Shop for low interest rates: Do research and talk to several lenders to find the lowest interest rate possible. That will help you save money on interest every month. Debt consolidation makes the most sense when you can get an interest rate lower than what you currently pay on your debts.
  • Read the fine print: When taking out a debt consolidation loan–and any other loan, for that matter–be sure to know the exact terms of the loan. That includes length, total balance, interest rates, and fees. A longer loan term can help lower your monthly payment amounts, but it can also raise the total amount you’ll pay over the life of the loan. Make sure to discuss all of this with lenders so you know exactly what you’re paying during the course of the loan.
  • Make your monthly payments on time: Again, payment history is the most important part of a credit score. By making on-time payments every month, you’re paying down the loan balance while helping your credit score.

What to avoid when consolidating debt

The great thing about consolidating debt is combining multiple debts into one loan, ideally at a lower interest rate, that you can pay off monthly. But there are a few things you should avoid when consolidating debt:

  • Missing payments: It bears repeating. Missing payments is the worst thing for your credit score. When you miss a payment, you’re hurting your credit score and possibly getting stuck with late payment fees, which only add to your debt.
  • Taking the longest loan term available: Yes, a longer loan term will lower your monthly payments. But you’re now adding extra months of interest to your debt. The best advice is to balance out the payments and the term length according to your personal budget.
  • Running up credit card balances again: It is very satisfying to see 0.00 on your credit card statements once you’ve consolidated your debt and used your new loan to pay off all of those balances. And it can be tempting to start charging items back to a credit card–either your old credit card or a newly opened one if you closed your credit card account once the debt was paid–since you have no balance. But that can be very dangerous. You just consolidated all your debt–the last thing you want to do is run up even more debt and worry about having to pay that off.
  • Applying for more loans: It’s best to avoid applying for a new loan when you’ve consolidated your debt for two reasons. First, you just combined all your debts, and applying for another loan adds one more monthly payment. Second, remember that your credit score will be lower after applying for and opening a debt consolidation loan. That makes your application less appealing to lenders.

The bottom line 

A debt consolidation loan is not a solution to your credit card debt–that requires a change in spending habits. But it can help by combining all your current debts into one monthly payment. If you can get a lower interest rate on a debt consolidation loan, you may even be able to save some money. 

Just remember to shop for the best interest rates, talk to lenders about what exactly your debt consolidation loan looks like, make your monthly payments on time, and avoid taking on more debt. Sun Loan is here to help you with debt consolidation by offering fixed-rate loans with affordable monthly payments and a clear finish line. 

Consolidating your debt with Sun Loan will not only streamline your debt into one monthly payment, but it can also help you improve your credit as you make your payments on time. 

You can apply for debt consolidation online or stop into one of our local branches, where a loan specialist will guide you every step of the way. We’re also available to answer any questions you have–call us at (800) SUN-LOAN!

Author – Holly Munoz

Holly Munoz serves as Regional Vice President at Brundage Management, the management holding company that operates Sun Loan and related subsidiaries. Holly has over 15 years of experience in the loan ... Read more »

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