In this article:
- How Long Debt Consolidation Stays on Your Credit Report
- How Does Debt Consolidation Affect Your Credit?
- How to Minimize the Impact of Debt Consolidation
Debt consolidation is a process that involves paying off one or more existing debts with a new loan or credit card, preferably with a lower interest rate. When you open new credit, it can have a temporary negative impact on your credit score.
But if you use the process to pay down your debt on time, it can ultimately improve your credit and overall financial well-being. Here's what you need to know.
How Long Debt Consolidation Stays on Your Credit Report
The act of consolidating your debt doesn't appear on your credit report, but the new loan or credit card account you use typically will. Exactly how long that account remains on your reports will depend on the type of credit you use and how you manage your debt payoff plan.
Balance Transfer Credit Card: Up to 10 Years or Indefinitely
A balance transfer credit card is a type of card that comes with an introductory 0% annual percentage rate (APR) promotion, allowing you to pay down high-interest balances over 12 to 21 months interest-free.
If you keep the card open after you pay down your balance, the account will remain on your credit reports indefinitely. If you always pay your bill on time and close it in good standing, that positive information will stay on your reports for 10 years from the date the card was closed. However, if you missed a payment by 30 days or more, that negative mark will last for seven years from the original delinquency date, or the date the account first became past due.
Personal Loan: Up to 10 Years
A personal loan is another popular debt consolidation tool. While it won't give you a 0% APR, it does provide a fixed repayment term, which can be helpful if you've struggled to stay disciplined with your debt payoff plan. Also, if you have good or excellent credit, you may be able to secure a lower interest rate than what you're currently paying.
Unlike credit cards, there's no way to keep a personal loan account open indefinitely. But if you make all your payments on time, the account will remain on your credit reports for 10 years after it's closed. If you miss a payment or stop repaying your loan, that negative information will stay on your credit reports for seven years from the original delinquency date.
Other Debt Consolidation Options: Up to 10 Years
Depending on your situation, you may consider other ways to consolidate your debt, such as a home equity loan, home equity line of credit (HELOC) or 401(k) loan:
- Home equity loans: A home equity loan can have repayment terms of up to 30 years, but in terms of your credit report, they work similarly to personal loans: Positive information remains on your credit reports for 10 years after account closure, while negative information stays for seven years from the original delinquency date.
- HELOC: While HELOCs function similarly to credit cards in many ways, they generally can't be kept open indefinitely; repayment terms usually range from 10 to 30 years. In other words, the same rules apply with positive and negative account information.
- 401(k) loan: Unlike other consolidation options, 401(k) loans don't show up on your credit reports at all because you're essentially borrowing money from yourself.
How Does Debt Consolidation Affect Your Credit?
Depending on which type of financial product you choose to consolidate your debt, the process can impact you in different ways. Here's a quick summary of the factors that come into play.
Payment History
Regardless of which option you choose—excluding 401(k) loans—making your payments on time will help improve your credit score.
If you miss a payment by 30 days or more, however, it could have a significant negative impact on your score. The longer you go without catching up on a missed payment, the more damage it'll do.
Credit Utilization Rate
With a credit card, your credit utilization rate is the percentage of available credit you're using at a given time on revolving credit such as credit cards. If you consolidate a credit card balance with a personal loan, home equity loan, HELOC or 401(k) loan, that'll drop your utilization rate on that card down to 0%, which can improve your credit—especially if your utilization was high to begin with.
If you use a balance transfer credit card, however, the impact will depend on the credit limit of the new account. If transferring the debt results in a lower utilization rate than what you had on the original card, it could improve your credit score. If it's higher, it could hurt your credit until you pay it down.
Length of Credit History
Each time you open a new credit account, it reduces the average age of all of your credit accounts, which is a factor in your credit scores. As a result, your credit score may experience a temporary dip, though it can rebound as your average age of accounts increases again. Just be careful to avoid opening loans and credit cards too often.
New Credit
Applying for credit frequently can be an indicator of risk for lenders. Also, each time you apply for credit, the lender will run a hard inquiry on your credit reports. One new inquiry won't have much of an impact on your credit score, and inquiries only affect your score for the first 12 months.
But if you apply for multiple loans or credit cards in a short period, those inquiries can have a compounding negative effect on your credit unless you're rate-shopping certain types of loans.
How to Minimize the Impact of Debt Consolidation
Using debt consolidation to improve your financial situation can also have a positive impact on your credit score over time.
But if you're not careful, certain aspects of the process could do more harm than good. Here are some tips to help you minimize the potential negative impact of debt consolidation on your credit score:
- Keep old credit cards open. If you're consolidating credit card debt, you may be tempted to close the old accounts once the process is complete. But closing credit cards can negatively impact your credit. Unless keeping the account would be costly—for example, the card has an annual fee, or you'd be tempted to rack up more debt—avoid closing it.
- Avoid adding more debt. After you pay off a credit card balance, avoid adding more debt that you can't afford to pay off in full each month. Otherwise, it can slow your progress toward becoming debt-free.
- Avoid applying for too many accounts. This can help keep the negative impact of credit inquiries and new credit accounts to a minimum.
- Always pay on time. Your payment history is the most influential factor in your credit scores, so it's crucial that you always pay your bills on time. Before you apply for a loan or credit card, make sure the new monthly payment comfortably fits in your budget and set up automatic payments or monthly reminders to pay manually.
Check Your Credit Before You Apply for Consolidation
Most of the best consolidation options require good or excellent credit to get approved or to enjoy favorable terms. So, it's a good idea to check your credit score before you apply for new credit. If your credit needs some work, you may consider other debt repayment strategies while you work on improving your credit.
