When you have thousands of dollars of credit card debt spread across multiple cards, consolidating it into one monthly payment can help you organize your finances. There are a few ways to consolidate, including transferring balances to one card, taking out a large installment loan or using a debt consolidation company. Each has a different effect on your credit score, and if you are careful, you can consolidate debt without ruining your credit.
Balance Transfers
Transferring balances between cards can hurt your credit score, depending on how you do it. If you open a new card, this will slightly lower your credit score because of the credit inquiry and new account. In addition, if the balance you move puts the card close to its credit limit, this will hurt your score. The best way to transfer balances without hurting your credit score is to use a card with a high credit limit and keep the other cards open after you transfer balances off. This keeps your overall ratio of balances to limits as low as possible. However, it can also tempt you to continue using the other cards and accumulate more debt, which will hurt your score.
Installment Loans
Another way to consolidate credit card debt is to get a large installment loan, which you pay off over a set time period with equal monthly payments, and use the money from the loan to pay off all your credit cards. As with opening a new credit card, applying for and opening a new installment loan slightly lowers your credit score. However, one advantage is that the ratio of your credit card balances to their limits will significantly drop when you pay them off, increasing your score, as long as you do not charge up balances on them again. A potential disadvantage of an installment loan is that the large monthly payment might be too much to handle. If you couldn't pay all your credit cards separately, you are unlikely to be able to afford a large payment that combines them all. Missed payments will hurt your credit score, especially if they are chronic.
Debt Consolidation Service
Many companies offer debt consolidation services. They might collect one monthly payment from you and distribute it to all of your credit card companies and other lenders, or they might arrange an in-house installment loan. The disadvantage of these companies is that you usually have to pay high interest rates and fees that increase the cost of repaying the debt above what you would pay if you managed it yourself. Therefore, your credit score will not increase as fast as it should. In addition, if you allow another company to deal with your creditors, it might miss payments on your behalf and ruin your credit score.
Bottom Line
The elements of debt consolidation that can hurt your credit score include opening new credit cards or loans, having high balances on your credit cards in relationship to their limits and missing payments on any of your debts. However, there are ways to consolidate your debt that will damage your score minimally to begin but eventually help your score. Focus on opening no more than one new account, establishing an affordable monthly payment, sticking to the payment schedule and not using your credit cards to build up more debt after you consolidate.
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