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Does Debt Consolidation Impact Your Credit Score?

Debt consolidation can simplify repayments and potentially improve credit scores, but also carries risks that might negatively impact your credit.

Debt consolidation can provide relief if you’re struggling with multiple debts and find monthly payments unmanageable. But does debt consolidation affect your credit score?

As a debt solution, consolidation aims to simplify your repayments and potentially save you money in interest. However, it can still influence your credit in both positive and negative ways.

Understanding how debt consolidation works, along with taking steps to minimise risks, is key in making the most informed decision possible. Here at Consolidation Expert, we provide a detailed breakdown on how debt consolidation may impact your credit score, and whether it’s the right choice for you.

Key Takeaways:

  • Consolidating debt means combining multiple debts into one, e.g. by taking out a consolidation loan. This makes repayments simpler and easier to manage, and often results in a lower interest rate.
  • Debt consolidation may help to improve your credit score by lowering your credit utilisation ratio, reducing the risk of missed payments, and building a positive payment history.
  • However, account closures and credit checks may lower your score in the short term and as with any other form of credit, missing a consolidation loan repayment may also negatively impact your credit rating.
  • Responsible management, realistic loan amounts, and diligent monthly payments are key to success.

What Is Debt Consolidation?

Debt consolidation is a way of merging multiple unsecured debts, such as credit cards, store cards and payday loans, into one loan with a single monthly repayment. This can help make it easier for the borrower to manage their finances, providing a structured plan towards becoming debt-free. It also removes the hassle of dealing with multiple creditors.

Often, debt consolidation can help save the borrower money by reducing the interest charged on what they owe. It may also be used to extend the repayment period, thereby reducing the amount repayable each month – though it’s important to note that this may mean paying more in interest over time.

There are many ways to consolidate debt, such as:

01. Debt Management Plans

A Debt Management Plan (DMP) is an informal agreement between a borrower and creditors to pay off their debts through a debt management company. A single payment is made to the company each month, who then divides it between each creditor. The DMP Provider may take a fee from the payment before dividing the remainder between creditors. The borrower’s accounts remain open, though DMP providers can often negotiate lower interest rates and reduced fees. As it’s not legally binding, creditors are not obliged to agree to the terms of the plan.

02. Balance Transfer Credit Cards

Balance transfer cards allow borrowers to consolidate multiple credit card balances into one. The debts get transferred to the new card, so only one bill has to be paid each month. The new card may have a lower initial interest rate – however, the rate may increase substantially after a set period of time (e.g. 12 months). Balance transfer credit cards can only be used to consolidate credit card debt.

03. Debt Consolidation Loans

Debt consolidation loans provide the borrower with a sum of money which is used to pay off each of their creditors in full. This leaves them with only one loan to repay, which may have a lower interest rate and a longer repayment term.

Secured loans use an asset like a house or car as collateral, meaning you may lose the asset if you default on the loan. With unsecured consolidation loans, no collateral is required, but interest rates are often higher and there may be stricter approval criteria.

Each consolidation approach has pros and cons to weigh regarding interest rates, fees, and how accounts get handled. Always seek professional advice, as the right choice will depend on your financial situation.

How Does Debt Consolidation Help Credit?

Used responsibly, a consolidation loan can positively influence your credit in a few ways:

01. Lower Credit Utilisation Ratio

By using a consolidation loan to pay off your credit cards and store cards, you’ll reduce your credit utilisation ratio (the amount you owe compared to your credit limit). A lower utilisation ratio can positively affect your credit score, as it indicates that you’re more financially responsible and not overly reliant on credit.

02. Simplifying Repayment Tracking

One of the primary benefits of a debt consolidation loan is that it combines multiple debts into one, with a single monthly payment. Compared to juggling multiple different due dates and amounts, a single payment is typically easier to manage and keep track of. This can help to reduce your risk of missing a payment, making a late payment or defaulting – all of which can have a significant negative impact on your credit score.

03. Building Payment History

If you consistently make on-time payments on your debt consolidation loan, you’ll build a positive payment history. Payment history is a significant factor in determining your credit score.

Credit bureaus want to see you can handle instalment loan payments responsibly over an extended time. This demonstrates lower lending risk.

04. Diversifying Your Credit Mix

Lenders in the UK often like to see a mix of different types of credit on your report. By adding an instalment loan (like a debt consolidation loan), this might help to diversify your credit mix, especially if you’ve only had one type of credit before. As a result, your credit score may improve, so long as you don’t close all your other accounts.

How Could Debt Consolidation Hurt My Credit?

While consolidation loans carry multiple potential benefits to your credit score, there are also some risks to consider:

01. Loan Inquiries

Applying for any type of loan, such as a debt consolidation loan, can trigger hard inquiries on your credit file. This may cause a temporary dip in your credit score. Multiple applications in a short period can exacerbate this effect.

This is because inquiries indicate you are actively seeking new credit. Seeing many in a few months raises lender concerns that you may be taking on excessive debts.

02. Account Closures

If you use the consolidation loan to pay off other credit accounts and then close them, it can reduce the average age of your credit accounts, which is a factor in your credit score. Older accounts generally have a positive impact on your score due to their longer history, especially if it’s a positive history (no or few missed payments).

If you close all of your other credit accounts (except for the new loan), this can also result in a less diverse credit mix, which may also negatively impact your score.

03. Missed Consolidation Loan Payments

Becoming overdue or delinquent on the new consolidation loan can hurt your credit just like any other loan. Consistent on-time payments are crucial for maintaining a healthy score.

The positive effects of consolidation rely on diligently making monthly payments on time. Just one 30-day late payment can have an impact on your credit rebuilding progress.

04. Potential for Further Debt

There’s a risk that once you’ve consolidated your debts and cleared your credit card balances, you might be tempted to use them again. This can lead to accumulating more debt, which can harm your credit score and financial health.

The consolidation process only works long term if you change spending tendencies and avoid balance creeping back up on newly freed up credit cards.

How Can I Minimise the Impact of a Consolidation Loan on My Credit Score?

If you’re considering a debt consolidation loan, it’s essential to take steps to minimise any potential negative impacts on your credit score. Follow these guidelines to reduce risks when pursuing debt consolidation:

01. Compare Loan Offers

Compare multiple lenders to find the best rates and terms to minimise costs. Looking at multiple lenders increases chances of securing the most favourable interest rates and fees, saving you money.

When looking for a debt consolidation loan, use ‘soft search’ or ‘eligibility checker’ tools first. These allow you to see which loans you might be eligible for without impacting your credit score. Only once you’ve found a suitable offer should you proceed with a full application.

02. Borrow Only What You Need

Carefully consider the loan amount needed to consolidate your debts in full and avoid future reliance on revolving credit.

Underestimating the loan amount required to pay all debts leaves open accounts and defeats the full benefits of debt consolidation. However, borrowing more than necessary can lead to higher debt levels and negatively impact your credit utilisation ratio.

03. Automate Payments

Make payments on time every month to build a positive history and avoid damage to your credit score. Scheduling payment reminders, signing up to a direct debit agreement or setting up a standing order can help you avoid the risk of missed or late payments.

04. Limit New Credit

Avoid applying for new credit while repaying the consolidation loan. Too many inquiries will depress your scores.

Keep new credit applications to a minimum in the months following consolidation to avoid excessive score-lowering hard inquiries.

05. Use Freed Up Credit Selectively

Once you’ve consolidated, resist the temptation to use your now-cleared credit cards or take on additional loans. This can lead to a cycle of increasing debt. Use freed up credit wisely to maintain low utilisation: ideally, try to keep your balances below 30%.

06. Avoid Closing Old Accounts

If you pay off credit cards with your consolidation loan, consider keeping the oldest accounts open to preserve the length of your credit history. Hold off closing your longest-standing accounts if possible, especially if they have a positive payment history. Their age should contribute positively to your credit score.

Just ensure there’s no annual fee and be disciplined about not accumulating more debt on them.

07. Contact Lenders with Payment Issues

If you ever face difficulties making repayments, communicate with your lender as soon as possible. They might offer solutions or adjustments to your repayment plan, which can prevent missed payments and further damage to your credit score.

08. Consider Alternative Debt Solutions

Depending on your financial situation, other potential solutions, such as a balance transfer credit card, Debt Management Plan or an Individual Voluntary Arrangement (IVA), might be more suitable. However, these options can also impact your credit score, and each come with their own set of pros and cons. It’s essential to understand the implications fully before deciding.

Should I Consolidate My Debts?

The bottom line: debt consolidation can positively or negatively impact your credit score, depending on how you manage the process. The benefits are typically greatest for those with:

  • Unaffordable monthly payments: If keeping up with minimum payments on several accounts has become impossible, consolidation can make it less likely that you’ll default.
  • High-interest balances: People who have multiple high-interest debts, such as credit card balances, can significantly benefit if they secure a consolidation loan with a lower interest rate.
  • Financial discipline: Those who can avoid accumulating more debt after consolidating benefit the most. Making consolidation succeed requires commitment to changing your spending habits and dedication to making new loan payments consistently.

It’s crucial to approach debt consolidation with a clear understanding of one’s financial situation and goals. The positive impacts of debt consolidation can quickly be negated if one falls back into poor financial habits, such as racking up additional debt or missing payments on the consolidation loan. As always, seeking independent financial advice before making such decisions is recommended.

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Apply With Consolidation Expert Today

Debt consolidation should not be treated as a quick fix or cure-all for credit challenges. But when pursued strategically, it can be an opportunity for a fresh financial start, providing lasting benefits that set you on the path to restored financial health and improved credit.

At Consolidation Expert, we may be able to help you consolidate your debts into one loan with an easy monthly repayment. For more information, or to see if debt consolidation is the right choice for you, apply with Consolidation Expert today.

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Representative 14.8% APR

We are a broker, not a lender.

Representative Example: Borrowing £15,000 over 60 months, repaying £355.28 per month, total repayable £21,316.57.

Total cost of credit £6,316.57.

Interest rate 14.8% (variable).

The lenders on our panel offer loans for 12-360 months, with rates from 4.7% APR to 42.6% APR.

The Representative Example is based on all loans paid out by lenders between 1st Jan 2022 and 31st Dec 2022.

Further reading

Read Is it Possible to Consolidate Short-Term Same Day Loans?
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Read Can I Consolidate Holiday Loans with Other Debts?
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Read How Can I Pay Off My Debts Faster?
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