Recognize the dangers and pitfalls first. A balance-transfer card or loan can help you consolidate your debt if your credit card bills are mounting and you're at your wits' end. However, doing so might negatively affect your credit in the long run. While combining your outstanding balances can make repayment easier, less stressful, and, most importantly, save you money over time on interest, if you're not careful, this strategy could harm your credit history and score. Find out how credit damage caused by debt consolidation works.
Hard inquiries impact your credit report
A "hard inquiry" is recorded on your credit report when you apply for a new credit account to consolidate debt because the lender will check your credit. Because lenders view new credit applications as a sign of risk, each hard inquiry can temporarily lower your credit score by up to five points. Apply only for loans or balance transfer cards that you are eligible for to avoid taking a big hit. Don't frantically apply for new accounts while hoping one of them will be accepted. A credit card or personal loan application that results in multiple hard inquiries in a short period will be detrimental. Although those inquiries will only have a short-term effect on your credit score, the records will stay on your credit history for two years, which could raise concerns in the eyes of potential lenders. Before submitting an application, a tip is to check your credit score and note whether it is considered fair, good, or excellent. Make use of that data to aid in your loan or credit card selection. The good news is that if you are consolidating debt, you probably won't (and shouldn't) open another new line of credit anytime soon, so a brief drop in your credit score might not matter.New Accounts Decrease Your Credit Age Average
The average age of all your credit accounts will decrease if you open a new credit card or take out a loan to consolidate your debts; this may temporarily lower your credit score. The length of your credit history, which includes the age of your newest account, accounts for 15% of your FICO credit score. Your credit score will rise as the account gets older and you make on-time payments because a new account doesn't yet have a good credit history. Although some situations cannot be avoided, the following three can. Pay close attention, so you know what to avoid after debt consolidation to keep your credit score high. After consolidation, accruing more debt increases the utilization rate One of the greatest dangers of debt consolidation is that you could accrue new debt before paying off your old balance. Any credit score improvements you notice will vanish quickly if you give in to the spending temptation of a recently paid-off credit card. This is why: Your total amount of available credit rises when you consolidate your debt into a new account to pay off other credit cards, reducing your credit utilization ratio. Your FICO credit score will increase if that ratio decreases. (It contributes 30% to your final score.) You will put yourself in trouble once more if you don't leave those credit limits on your older cards alone. As an illustration of how adding new debt on top of consolidated debt will raise your credit utilization ratio and negatively impact your score, consider the following: Credit and Card Limit After Debt Consolidation, Balance Balance After Consolidation of Debt Plus New Debt First card: $2,000 limit $0 $500 Second card: $3,000 limit $0 $1,200 Third card: $5,000 limit $0 $2000 Fourth card: $15,000 limit (balance transfer card used for consolidation) $7,000 $7,000 Credit Utilization Ratio: 28% 43% Restrict your spending, or you'll soon find yourself managing several debts, including a sizable account of consolidated debt. This could quickly exceed your financial means, resulting in missed payments or, worse yet, default.Closing Old Credit Cards Lowers Credit Available
If the previous warning scared you, don't go too far in trying to cut back on your spending. That is, refrain from canceling your old, balance-free credit cards. Your credit score will be impacted by that as well. You can improve your credit score while paying off your consolidated debt by keeping the cards open and paid off. This will lower that crucial credit utilization ratio we just discussed. Your credit score will suffer if the cards are closed. Using the same four card scenarios, here is an illustration of how closing unused credit cards could increase your credit utilization ratio: Credit and Card Limit After Debt Consolidation, Balance Balance Following Debt Consolidation + Closing of Cards First card: $2,000 limit $0 N/A Second card: $3,000 limit $0 N/A Third card: $5,000 limit $0 N/A Fourth card: $15,000 limit (balance transfer card used for consolidation) $7,000 $7,000 Credit Utilization Ratio: 28% 47% See how those unused cards can assist you in paying off the balance transfer card? Therefore, keep open cards open rather than closing them while reducing the balance on your combined debt. If you're prone to giving in, but the physical cards in a safe or freeze them. Make sure to stop all automatic payments from those cards and remove saved card information from any online shopping accounts in order to avoid giving in to temptation in the future. A word of caution: If you have a serious concern about overspending and your finances are already tight, closing blank cards may be in your best interest. Your credit score may temporarily suffer, but you can recover from that kind of setback more quickly than from taking on additional burdensome debt. Just be sure to close cards carefully.Missing or being late with payments tarnishes credit history
You must make all of your monthly debt consolidation payments until the balance is paid in full and on time. Your payment history largely influences your FICO score, and a history of late payments will lower it. Your account will become delinquent, and the lender will send it to collections if you ignore the debt consolidation balance and completely stop making payments. Your credit will suffer greatly while collection records are still on your report for seven years. Call your credit card or loan issuer if you suddenly have financial problems and are concerned you'll miss a payment on your consolidated debt before it's too late and your credit score suffers. Options for overcoming financial hardship might be available.Final Verdict
Consolidating debt into one low-interest account, whether it be a balance-transfer credit card or loan, can ease the burden and reduce your credit utilization ratio if you consistently make on-time payments and don't take on any additional debt. Your credit score won't suffer any immediate harm, but it will eventually recover. Additionally, wise credit use in the future will raise your credit score over time and help you stay out of another situation where debt consolidation is necessary.