While combining your outstanding balances can simplify repayment, reduce stress, and most importantly, save you money on interest over time, this approach can ding your credit score and history if you’re not careful. Learn how debt consolidation can hurt your credit.
Hard Inquiries Ding Your Credit Report
When you apply for a new credit account to consolidate debt, the lender will check your credit, leading to a so-called hard inquiry on your credit report. Each hard inquiry can temporarily lower your credit score by up to five points because lenders look at new credit applications as a sign of risk. To avoid a big hit, only apply for a loan or balance transfer card you can qualify for. Don’t apply for new accounts left and right and cross your fingers for approval. Multiple hard inquiries created by a credit card or personal loan application in a short period of time will definitely hurt. While those inquiries will only impact your credit score for a year, the records will linger on your credit history for two years, which could be a red flag to future lenders. On the plus side, if you are consolidating debt, you likely won’t (and shouldn’t) open another new line of credit any time soon, so a temporary dip in your credit score may not matter.
New Accounts Lower Your Average Credit Age
Opening a new credit card or taking out a loan for debt consolidation will lower the average age of all your credit accounts, which may also temporarily lower your credit score. The length of your credit history makes up 15% of your FICO credit score and specifically factors in the age of your newest account. A brand new account doesn’t yet have a positive credit history, so your score will benefit as you make on-time payments and the account ages.
Racking Up More Debt After Consolidation Raises Utilization Ratio
One of the biggest risks associated with consolidation is running up new debt before you’ve paid off your old balance. If you succumb to the spending temptation of a newly paid off credit card, any credit score improvements you see will quickly disappear. Here’s why: When you consolidate your debt into a new account to pay off other cards, your overall amount of available credit increases, lowering your credit utilization ratio. The lower that ratio is, the better your FICO credit score will be. (It accounts for 30% of your score.) But, if you don’t leave those credit limits alone on your older cards, you’ll get yourself in trouble again. Here’s an example of how piling new debt on top of consolidated debt will increase your credit utilization ratio and be a drag on your score: By keeping the cards open and paid off, you will reduce that oh-so important credit utilization ratio we just discussed, positively impacting your credit score while you pay down your consolidated debt. Close the cards and your credit score will take a hit. Here’s an example of how closing unused credit cards could raise your credit utilization ratio, using the same four card scenarios:
Being Late or Missing Payments Clouds Credit History
It’s absolutely crucial that you make all your debt consolidation payments on time each month until the balance is repaid. Payment history has the biggest influence on your FICO score, and records of late payments will damage it. If you ignore the debt consolidation balance and stop making payments altogether, your account will become delinquent and the lender will send it to collections. Collection records stay on your credit report for seven years and until that time passes, your credit will suffer immensely. If you are suddenly facing financial difficulties and worried you’ll miss a consolidated debt payment, call your credit card or loan issuer before your payment becomes late and your credit score takes a hit. There may be financial hardship options available.
