October 30, 2019

debt consolidation affect credit

If you have racked up the debt across the years, don’t feel bad! Just about everyone has accumulated a substantial amount of debt at one point or another. After all, most people cannot afford to pay for a college education, a home, an automobile, and other costs of living without loans or a credit card.

Though debt consolidation is tempting, the little-known truth is it can backfire in a big way. The question begs: How does debt consolidation affect your credit? We have the answers.

How Debt Consolidation Damages Your Credit Score

Those who work in the personal finance niche are often asked: “If I pay off a debt, will my credit score go up?” Contrary to popular opinion, the consolidation of debt does not automatically guarantee a higher credit score. It is possible consolidating your debt will actually lead to a lower credit score.

As an example, your credit score can decrease after transferring several credit card balances onto one credit card as this action will reduce your total lines of credit while simultaneously chewing up your remaining credit on the account that is still active. If you are not careful, consolidating debt into a single line of credit can leave you with little-to-no credit at all. If you max out your lone credit card, you will have utilized the entirety of your credit and end up with a lower credit score due to an egregiously high utilization ratio.

Credit History Matters

Consolidating lines of credit into one or two lines erases your positive credit history with multiple lenders. Credit history matters a great deal in the context of your credit rating. There is no sense paying off credit over the years only to close those accounts and offset the positive impact on your credit score. Do not lose sight of the fact that payment history is the most important factor in determining a credit score.

Even if you were to shift your debt to one or two lines of credit, the move could backfire as you will be that much more tempted to run up a balance on the cards with zero or a minimal balance. As a general rule of thumb, it is never a good idea to run up a considerable amount of debt on any type of line of credit, be it a credit card or anything else.

The Risk of Taking out a new Line of Credit for Debt Consolidation

Some people go to the extent of opening one or several new lines of credit to consolidate their debt. Though this strategy makes sense in certain circumstances, it will reduce your credit score. This reduction occurs as a result of the hard inquiry necessary to secure the new line(s) of credit in the first place.

The Temptation to Maintain the Status Quo

Consolidate your debt into one or two lines of credit and you will undoubtedly be tempted to continue spending as you did prior to the consolidation. After all, consolidation in which accounts are kept open at a zero balance will create the temptation to spend even more money.

Consolidation Can Lead to the Payment of Even More Interest

Consolidate your debt and you just might run up an even larger credit card bill that results in the payment of even more interest across the life of the debt than would have occurred had you not consolidated in the first place. So, don’t be quick to assume consolidation will result in lower monthly payments and immediate relief from a seemingly insurmountable debt load. Oftentimes, the better solution is to continue paying down multiple lines of credit and bite the bullet on the accompanying interest payments.

Continue making payments and you will eventually reach a zero balance in which there is absolutely no interest to pay. We’re experts at eliminating debt with a proven, predictable, and stable way to pay it off for good. Contact us today to learn more.

photo of Jeff Mohlman

By Jeff Mohlman

Jeffrey has developed a comprehensive network of financial planning and estate planning experts who work for their client’s short-term and long-term goals. Today, the approach he incorporates for his clients follows three basic tenets: 1) being debt-free, 2) maximizing after-tax retirement income, and 3) protecting their estate from unforeseen risks.