How Long Will Debt Consolidation Damage Credit?

The damage to your credit comes not from consolidating your debt, but mainly from how you handle the consolidation. While both consolidation loans and debt management plans cause a small initial negative impact on your credit score, those may be outweighed by the positive impact of paying off your debt and keeping it paid off. However, often people fall further into debt as a result of consolidation because they don't learn the lesson of becoming financially responsible prior to taking on the consolidation.

Consolidation Loans

When you apply for a consolidation loan, the lender makes an inquiry into your credit report to determine whether to lend you the money. However, after that, any damage that comes from a consolidation loan is the direct result of your actions. Once a consolidation loan pays off the balances on your existing debt, you may be lured into contributing further to your debt, propelling yourself quickly into a higher debt-to-credit ratio and making it difficult for yourself to make payments each month. Both your debt ratio and making on-time payments are top considerations in calculating your credit score, and the effects last as long as you allow them to. If, however, you pay off your debt with a consolidation loan and keep it paid off, your credit score will get a considerable boost.

Debt Management Plans

A debt management plan (DMP) doesn't effect your credit score but rather your ability to obtain credit in the future. A DMP is the last stop on the way to bankruptcy, and you must have defaulted on payments and be having difficulty meeting minimum payments to qualify for one of these plans. On a DMP, a credit counselor negotiates with your creditors for lower interest rates and pays off balances. As a result, lenders see DMPs as a dark mark on your credit report because it indicates that you've had difficulty making payments and that you didn't pay back the full amount of your debt. A DMP may stay on your credit report for up to seven years.

Warnings

You are usually required to put up collateral, such as your house, when you take out a consolidation loan. If you default on your payments, the lender has the right to garnish your assets. With debt management plans, you must be careful to use a reputable company; if the credit counseling company fails to make the payments to your creditors on time, your score will plummet dramatically. The Association of Independent Consumer Credit Counseling Agencies or the National Foundation of Credit Counseling are both organizations that can confirm whether your credit counseling service is reputable.

Considerations

Because of the potential damage to your credit score and the risk associated with consolidation, consider your options for paying off your debt on your own. Often, the interest rates offered with consolidation loans are only available to those with excellent credit. You may end up getting a better rate by simply calling your creditor and asking for a lower interest rate. If you end up with a rate comparable to the one offered to you by a consolidation loan, you get the same outcome without the risk of being unable to obtain new credit.