Does a Debt Consolidation Loan Affect Your Credit?

If you're considering debt consolidation, you should first make sure that you're completely committed to paying off your debt and keeping it paid off. The way that you handle a consolidation loan determines how much of an effect it has on your credit score. If you make on-time payments and stop contributing to your debt, a consolidation loan may be the key to climbing out of the hole. However, if you continue to spend, you'll make matters worse and your credit score will take an even further hit.

Inquiry

A debt consolidation loan requires an application, and the lender must submit an inquiry to the credit bureaus to get a copy of your credit report. Inquiries create a small negative effect on your credit report; however, if you use the debt consolidation loan to clear your debt and stay out of debt, you will boost your score past any points lost during the application process.

Positive Effects

Because a debt consolidation loan wipes out the balances on your existing accounts, it appears as though you've paid off those accounts in full. This might bring up your credit score. Also, if you make on-time payments to the loan each month, eventually the history of timely payments will also add points to your score.

Negative Effects

According to Chris Viale, general manager of the nonprofit credit-counseling agency Cambridge Credit Corporation, 70 percent of people who take out debt consolidation loans find themselves in the same or more debt two years later. You must fully commit to paying off your debt to avoid sinking your credit score even further. Since the loan effectively clears your balance, you may feel inclined to use the newly freed credit. When you have difficulty making those payments, you will spiral further into debt and your credit score will plummet even faster.

Considerations

Although many debt consolidation lenders advertise loans with rock bottom low interest rates, it is important to realize those rates are only for people with very high credit scores. Ask for a quote and compare the interest rates with your existing accounts to make sure you're actually getting a better deal. Also, a debt consolidation loan is a turn off to lenders, and it may be difficult to get new credit once the loan appears on your report. Lenders want customers who can pay off their debt; a consolidation loan is a red flag that you've had difficulty making payments in the past.