When you consolidate your credit card debt, you replace multiple credit card accounts with a single loan or line of credit.
Many people with significant credit card debt never consolidate — and one of the top reasons is worry about what will happen to their credit score. But consolidating can actually have a positive effect on your score, as long as you make payments on time.
How you consolidate matters
There are two types of credit card debt consolidation: replacing multiple credit cards with a personal loan, or transferring multiple credit card balances to a single credit card.
While both approaches can make your payments easier to keep track of, they each have different impacts on your overall credit score. Let's take a closer look.
1. One monthly payment is easier to manage
True for both personal loans and balance transfers. When you have many credit card bills to pay every month, it’s easy to lose track. When you consolidate, you only have one monthly payment — and that alone reduces the risk you’ll forget one or miss a due date.
2. You improve your credit utilization ratio
True for personal loans. Your credit utilization ratio is the amount of debt you have vs. the total amount of credit available on each card. This accounts for a huge part of your credit score — about 30%.
If you move your credit card debts to a personal loan, you reduce your credit utilization, which can improve your credit score within a few months.
3. You diversify your debt
True for personal loans. Those of us in the industry refer to credit card debt as “revolving debt” — a loan that you can repeatedly add to. There isn’t a specific end date for paying it off, as long as you keep making minimum monthly payments.
“Installment debt” is a loan you take out once and pay off over time, such as a student loan, personal loan, or auto loan. You use it to pay for something big — like a college education — but you don’t continually add to it, like you would with a credit card.
Revolving debt is worse for your credit score than installment debt—and if you have only credit card debt, that can have an especially negative effect.
Switching some of your credit card debt to a personal loan has two benefits. It changes debt from revolving to installment — which helps your credit score — and it diversifies the type of debt you have, which also has a positive effect.
Of course, debt consolidation isn’t the right fit for everyone—and it doesn’t help your credit score in all situations. Here’s a look at the ways it can hurt your credit.
1. You’ll see a short-term hit to your credit
True for both personal loans and balance transfers. When you apply for a personal loan, your lender does a “hard pull” on your credit report to see if you qualify. This can ding your credit score in the short term. But this effect is generally temporary.
Most lenders will pre-qualify you before you decide, doing a “soft pull” to show you an estimated interest rate. This type of pull doesn’t affect your credit score, which means that you can feel free to shop around for the best rate.
With a balance transfer, your score is likely to get dinged for credit utilization if you're using a high percentage of the total available balance of a card. You'll need to get your utilization below 70% (and ideally, below 30%) to mitigate the impact.
2. You could start spending again
True for both personal loans and balance transfers. Freeing up some of your credit cards could make you feel tempted to start using those cards again.
If you think you're in danger of running up additional debt, consider closing some of your paid-off accounts or asking a trusted friend to hide your cards from you. Note that closing your accounts could actually ding your credit score though — having access to available credit is a positive on your credit report.
What's right for you?
Consolidating your debts can help your credit score, but it isn’t an instant fix. You still need to make your payments on time and avoid taking on more debt—which can be a challenge if you haven’t fixed the bad spending habits that landed you in financial hot water in the first place.
Consolidating your credit card debt can be a great solution — but it still requires self-control. Make every payment on time and avoid using your credit cards until you’ve improved your spending habits, and you should see your credit score rise after you consolidate.
Check out our picks for the best deals on debt consolidation loans.