Does Debt Consolidation Reduce Your Credit Score?

With money as tight as it's ever been in the United States, many people are trying to find ways to save money and pay off their debts. One way to eliminate credit card debt is to consolidate your debts. The impact of such an arrangement on your credit rating depends largely on your behavior after you receive the loan.

How It Works

When you consolidate your debts, you trade one form of debt for another. In most cases, consolidation comes in the form of a loan, which can be a personal loan or a home equity loan. You use the money provided in the loan to pay off your credit card bills, allowing you to make one payment to the bank instead of several payments to your individual creditors.

Benefits

The most obvious benefit to a consolidation loan is that you reduce the number of payments you must make each month, thereby making it easier to avoid late payments that can sabotage your credit score. In addition, you may be able to save money if your loan's interest rate is less than the interest rates on your credit cards. Lastly, your credit cards will be paid off, but your accounts will remain open, allowing you to access your credit if necessary.

Drawbacks

If you've run into problems with credit cards and assume the loan is going to take care of everything, freeing up your credit could create a new nightmare. Unless you learn how to live without credit, you might rack those cards up again, leaving yourself with not only the consolidation loan to pay off, but the cards once again as well. This can do serious harm to your credit because it will increase your debt and the chances of you falling behind on the payments on your cards.

Alternatives

One alternative, a debt settlement, could reduce what you owe, but could leave your credit score in tatters. A better option is a debt management program, in which a company works with creditors to reduce your interest rates, allowing you to pay off your debts more quickly. Many require you to pay the debt management company each month; it then pays your creditors. A condition of many debt management programs is that you must close your credit accounts; however, you'll also be building a consistent payment history, which does more to help your credit score than closing the accounts does to hurt your score.