You may have heard that consolidating your debts can hurt your credit score. So, if you’re considering this financial strategy to free up cash flow and otherwise streamline debts, it’s natural to wonder if that’s true. And like so many questions related to finances, the answer depends upon your specific situation.
It’s important to remember that a combination of many factors can affect credit scores and to understand how those factors are considered in credit score algorithms. We’ll use FICO® as an example—according to them, the high-level breakdown of credit scores is as follows:
• Payment history (35%): This includes delinquent payments and information found in public records.
• Amount currently owed (30%): This includes money you owe on your accounts, as well as how much of your available credit on revolving accounts is currently used up.
• Credit history length (15%): This includes when you opened your accounts and the amount of time since you used each account.
• Credit types used (10%): What is your mix? For example, how much is revolving credit, like credit cards? How much is installment debt, such as car loans and personal loans?
• New credit (10%): How much new credit are you pursuing?
Now, here is information to help you make the right debt consolidation decision.
Benefits of Debt Consolidation
When you’re juggling, say, multiple credit cards, it can be easy to accidentally miss a payment. Depending on the severity of the mistake, that can have a negative impact on your credit score. This, in turn, can make it more challenging to get loans when you need them, or prevent you from getting favorable loan terms, like low interest rates. Plus, even if you don’t miss a payment, when you have numerous credit card bills to juggle, you probably worry that one will get missed.
Plus, it’s not uncommon for credit cards to have high interest rates, and when you only make the minimum payments on each of them, you very well may be paying a significant amount of money each month without seeing balances drop very much at all.
So, when you combine multiple credit cards into one loan, preferably one with a lower interest rate, it’s much more convenient, making it less likely that you’ll accidentally miss a payment. And paying less in interest will likely make it easier to pay down your debt.
How you handle your debt consolidation, though, and the way in which you manage your finances after the consolidation each play significant roles in whether this strategy will ultimately help you.
Steps to Take: Before the Debt Consolidation Loan
Debt accumulates for different reasons for different people. For some, unexpected medical bills or emergency home repairs have served as culprits. For others, being underemployed for a period of time may have caused them to start carrying a credit card debt balance. For still others, it may be about learning how to budget more effectively.
No matter why credit card debt has built up, it can help to re-envision a debt consolidation strategy as something bigger and better than just combining your bills. As part of your plan, analyze why your debt accumulated and be honest about which ones were under your control and which were true emergencies.
And if you end up using a lower-cost loan to consolidate your bills, consider using any money saved to build up an emergency savings fund to help prevent the accumulation of credit card balances in the future.
The reality is that, if you consolidate your debts in conjunction with a carefully crafted budgeting and savings plan, then debt consolidation can be a wonderful first step in your brand-new financial strategy.
Debt Consolidation: When It Can Help Your Credit Score
Based on the factors used by FICO, here are ways in which a consolidation loan can help credit scores:
Payment history (35%)
Because making payments on time is the largest factor in FICO credit scores, a debt consolidation loan can help your credit if you make all of your payments on time.
Amount currently owed (30%)
Although you may not instantly reduce the amount you owe by, say, consolidating all of your credit card balances into a personal loan, there can be a benefit to your credit score here. That’s because the credit score algorithm looks at credit limits on your cards, as well as your outstanding balances, and creates a formula that calculates your credit card utilization.
Here is more information about credit card utilization, including how to calculate and manage yours.
Credit types used (10%)
As you may know, there are several different types of credit, such as credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans. According to myFICO , responsibly using a mix of these, such as credit cards and installment loans, may help your credit score.
However, it’s certainly not necessary to have one of each, and it’s not a good idea to open credit accounts you don’t intend to use.
Debt Consolidation: When It Can Hurt Your Credit Score
Now, here are ways that the same initial step—taking out a debt consolidation loan—may hurt your credit.
Payment history (35%)
As is the case with most loans, making late payments on a consolidation loan can hurt your credit score (depending on the severity of the situation). Loans in a delinquent status are mostly likely to have a negative impact on your credit, depending on the lenders’ policies.
Learn more about payment history .
Amount currently owed (30%)
Now, let’s say that you pay off all your credit cards with a personal loan and then you begin using them again to the degree that you can’t pay them off monthly. Any gain that you saw in your credit score will likely disappear as your credit utilization numbers rise again.
Another way that credit consolidation can harm your score is if you combine all of your credit card balances to just one credit card, resulting in a high utilization rate. But if you are able to keep it relatively low, it is less likely to negatively affect your score.
Learn more about amounts owed .
Credit history length (15%)
If you close credit cards that you pay off, you’ll reduce the age of your accounts, overall, and this can hurt your credit score.
Learn more about length of credit history .
Credit types used (10%)
If you combine all of your credit card balances into just one credit card, as described above, you won’t have opened an installment (personal) loan, so that won’t help with diversifying credit types.
New credit (10%)
If you apply for a personal loan or a balance-transfer credit card and are rejected, this can cause your credit score to decrease. And if you apply for multiple loans or credit cards, looking for a lender that will accept your application, this can also hurt your score. Multiple requests for your credit report information (known as “inquiries”) in a short period of time can decrease your score, though not by much.
Concerned about building or rebuilding credit? Check out a few tips SoFi put together on how to strategically boost your credit score.
Investigating a Personal Loan for Debt Consolidation
When it’s time to apply for the personal loan, you’ll want to get a low rate. In February 2019, the average credit card interest rate was reported as 17.67%; this means that, by not consolidating your credit cards into a personal loan with a lower interest rate, you could be paying more interest than if you did.
When choosing a lender, ask about the fees associated with the loan. Some lenders charge fees; others,like SoFi, don’t. You can always use a lender’s annual percentage rates (APRs) as a way to understand the true cost of financing.
Also, you may consider calculating the shortest loan term that your budget can comfortably accommodate because, the more quickly you pay off the debt, the more money you’ll save over the life of the loan because you’re paying less in interest.
You can find more information about saving money as you consolidate your debts, and you can also calculate payments using our personal loan calculator.
Consolidate Your Debt with a SoFi Personal Loan
If you’re ready to say goodbye to high-interest credit cards and to juggling multiple payments each month, a SoFi personal loan may be a good option.
Benefits of our personal loans include:
• Fast, easy, and convenient online application process
• Low interest rates
• No origination fees required
• No prepayment fees required
• Fixed rate loan
You deserve peace of mind. And by taking out a personal loan to consolidate debt, the stress of juggling multiple credit card payments can be history. Ready for your fresh start?
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .
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