Debt consolidation can seem like a great option when you’re struggling under the weight of high-interest credit card balances and multiple loan payments. Combining all those debts into one lower monthly payment can provide some much-needed relief.But before you jump into consolidation, it’s important to understand how it could impact your credit. Here’s a look at the potential pros and cons of debt consolidation when it comes to your credit scores.

How Debt Consolidation Affects Credit

When you consolidate debts, you take out a new loan to pay off your existing debts. This can affect your credit in a few key ways:

• New account: When you open a debt consolidation loan or balance transfer credit card, this new account will show up on your credit reports and can lower your average account age. This is a factor in your credit scores.
• Lower utilization: Consolidating balances from credit cards to an installment loan can lower your overall credit utilization ratio, which can help boost credit scores.
• Hard inquiries: Applying for the new loan requires a hard inquiry on your credit reports, which causes a small, temporary drop in scores.
• Account closures: If you close some credit card accounts after consolidating the balances, this can hurt scores by lowering total available credit.

So in the short term, debt consolidation can cause a minor drop in credit scores. But it also sets you up for credit score improvement as you make on-time payments and reduce balances.

Strategies to Minimize Credit Score Damage

If you want to consolidate debt in a way that limits damage to your credit, here are some tips:

• Compare offers: Limit hard inquiries by comparing offers within a short period, such as 14 days. Credit scoring models count multiple inquiries for the same loan purpose as just one inquiry.
• Leave accounts open: Unless required by the lender, leave consolidated accounts open with small balances to avoid lowering your total available credit.
• Make payments on time: Stay diligent with new loan payments to build positive payment history, the most important credit scoring factor. Set up autopay to avoid mistakes.
• Avoid new debt: Refrain from running up balances on the newly available credit on consolidated accounts to prevent increased utilization.
• Monitor credit: Check credit reports regularly to ensure the consolidated accounts are being reported accurately and avoid surprises.

Debt Consolidation Loans

One of the most popular ways to consolidate debt is with a personal loan. This combines multiple balances into one fixed-rate installment loan with set monthly payments over a term of generally two to seven years.Here are some pros and cons of using a debt consolidation loan:Pros

• Can get fixed interest rates lower than credit cards
• Simplifies finances with single payment
• Helps motivate you to pay off debt faster
• Can improve credit mix by adding installment loan

Cons

• Requires good credit for low rates
• Loan origination fees can be high
• Missing payments damages credit
• Temporarily increases hard inquiries

Debt consolidation loans are best for borrowers with good credit who qualify for low interest rates. Even a slightly higher rate can save substantially on expensive credit card interest.Be sure to shop around among multiple lenders, such as banks, credit unions and online lenders. Compare interest rates and fees to find the most affordable option.

Balance Transfer Credit Cards

Balance transfer cards allow you to consolidate credit card balances onto a new card at an introductory 0% interest rate for a set period, usually between 12 and 21 months. You typically pay a balance transfer fee of 3% to 5%.Here are some potential pros and cons with balance transfer cards:Pros

• Temporarily pause interest charges
• No set repayment schedule like a loan
• Useful if you need more time to pay off debt
• No prepayment penalties

Cons

• Deferred interest if not paid in full
• Need good credit for high limits
• Potential balance transfer fees
• Could overspend on freed-up credit

To avoid deferred interest, be sure to pay off the full transferred balance before the intro 0% rate expires. Balance transfers work best for those with good credit who need breathing room to pay off debt without racking up more high interest charges.

Alternatives to Debt Consolidation

Debt consolidation can be an effective strategy, but it’s not the only option. Here are a few other ways to tackle debt:

• Debt management plan: Work with a nonprofit credit counseling agency to negotiate lower interest rates and create a debt repayment plan.
• Debt settlement: Debt settlement companies negotiate to pay a portion of your debt in exchange for the creditor removing it from your credit report. This option damages credit scores.
• Credit counseling: Meet with a nonprofit credit counseling agency for free budget and debt help, including advice on debt consolidation.
• DIY debt payoff: Create your own debt payoff plan using the debt avalanche or debt snowball methods without consolidating.
• Bankruptcy: File for Chapter 7 or Chapter 13 bankruptcy to eliminate or restructure debts you can’t pay. This will severely damage credit scores.

The Bottom Line

Debt consolidation can provide a helpful credit score boost in the long run by streamlining payments and lowering credit utilization. But pursue consolidation cautiously, shop around for the best terms, make payments diligently, and avoid racking up new debt.With the right approach, debt consolidation can offer affordable debt relief without inflicting lasting damage on your credit. Focus on reducing balances, and your improved financial habits will be reflected in your credit.