How Does Debt Consolidation Affect Your Credit?

Consumers that are considering debt consolidation should also be asking about the consequences of debt consolidation on their credit scores. By the time a consumer is considering consolidation, credit payments have been late or the consumer is behind by a month or more on payments. The negative effect of missing credit payments on a credit report is widely known. But consumers should also understand how debt consolidation can affect a credit score before signing on the dotted line.

Late Payments

One of the best ways to improve your credit score is to pay your credit debt on time, according to the Federal Reserve Bank website. When you consolidate your debt, you are paying off the balances of your high interest credit card accounts. That means you no longer have minimum payments due on those accounts. No minimum payments mean you are no longer having late payments applied against your credit score, and that improves your credit status by stopping the damage that late payments were doing.

Mix

In order to have a high credit score, you need a mix of installment loans and credit accounts, according to the Federal Reserve Bank website. Installment loans are any long-term loans you have with regularly monthly payments such as a mortgage or a car loan. Too many loans, or too many credit accounts, is a bad thing for your credit score. Once you have consolidated your debt, you can choose to cancel your newest credit accounts while keeping the older ones. The more established a credit account is, the more it helps your credit score. This will improve your credit history and balance the mix between installment loans and credit accounts.

Responsible Use

Once you have used debt consolidation to pay off your credit accounts, you will have a chance to improve your credit by using your cards responsibly. Even when you have consolidated debt, having activity on your credit accounts that you can pay off each month will improve your credit score, according to Jason R. Rich writing on the Entrepreneur website. For example, set aside your food money each month but charge your groceries to your credit accounts. Then use the grocery money to pay the balance off. You will maintain your credit history without adding any new debt.

Trouble

Debt consolidation should only be used as a tool to help your financial situation, according to Jenny McCune, writing on the Bankrate website. While consolidating debt has the potential to improve your credit score, it can also lower your score if you do not exercise self-control. If you begin using your credit cards again and run up your balances to the maximum levels, then you are adding debt on top of the debt you have already consolidated. Your debt ratio, which is the percentage of your debt to your income, will suffer and your credit score will drop.