The simple act of consolidating your debt doesn't have a big effect on your credit score, but the way you choose to proceed with the consolidation does. You must be committed to a debt management plan or to paying off your consolidation loan if you have any hope of raising your credit score. If you become lured into further delinquency or you contribute even more to your debt, you will see your credit score continue to suffer.
Applying
Whether you're using a debt management plan (DMP) or a consolidation loan to consolidate your debt, the consolidation service or lender will have to make an inquiry into your credit. All inquiries create a negative effect on your score; however, if you use the consolidation to actually pay off your debt, the positive effect will more than make up for the decrease in your score.
Debt Management Plan
Creditors and lenders see a DMP as a dark mark on your credit report because it usually means you're paying back only part of your debt, and that you have had issues with your finances in the past. With a DMP on your record, it may be difficult to get new credit down the road. However, the DMP itself doesn't lower your actual score---it all depends on how responsible you are about sticking to your plan to repay your debt. Since you pay the credit counselor rather than your individual creditors while on a DMP, you must make sure the credit counseling company is credible, and is making your payments on time. Otherwise, their tardiness will force your score to plummet.
Consolidation Loan
The effect of a consolidation loan on your credit score is also dependent on your actions once you have the loan. A consolidation loan effectively wipes out your current balances, freeing up credit that you may be tempted to use. Then, instead of making one monthly payment toward your loan, you end up making multiple payments as you originally were before the loan, as well as payments to your consolidation loan. More debt equals a higher debt-to-credit ratio, and oftentimes leads to late payments and further spiraling into debt. Therefore, you must be fully committed to paying off your debt and keeping it paid off if you decide to use a consolidation loan. When used appropriately, and for the right reasons, a consolidation loan will help to boost your credit score in the long run.
Considerations
You must already be working with a credit counselor to apply for a debt management plan. Credit counselors usually recommend a DMP for those who are already delinquent on payments. It's likely that your credit has already taken a hit if a creditor suggests a DMP. Consolidation loans, on the other hand, are generally recommended for those who have collateral they can borrow against. Therefore, with the risks associated with overspending while on a consolidation loan, it's important to make sure that you're actually getting a better deal if you accept a loan.
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