Will a debt consolidation loan ding my credit score?

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(The Credible Money Coach explains the possible credit impact of a debt consolidation loan.)

Dear Credible Money Coach,

Is it true that when you do a debt consolidation loan, it hurts your credit? — Twila

Hello Twila, and thanks for your question. Debt consolidation affects your credit differently depending on how you structure it and manage the loan payments. It can be a wise way to manage multiple high-interest debts without hurting your finances.

If you’re considering a personal loan for debt consolidation, compare rates from multiple lenders to get the best offer. Credible makes it easy to see your prequalified personal loan rates in minutes.

Why do people consolidate debt?

When you consolidate debt, you open a new credit account, such as a personal loan, credit card, or home equity loan, to pay off multiple existing debts. That leaves you with one payment instead of multiple accounts to manage.

If you have good credit, you may be able to get a lower interest rate than the combined effective rate you’ve been paying on multiple debts. That saves money over the long run.

Ways to consolidate debt

There are multiple options for consolidating debt, including:

Taking out a personal loan.
Getting a 0% APR balance transfer credit card.
Getting a home equity line of credit (HELOC) or loan.
Doing a cash-out refinance on your home mortgage.
Borrowing from a retirement account.
Going on a debt management plan.

Each of those options has pros and cons. For example, personal loan interest rates are typically lower than credit card rates. But if you continue making credit card charges, you could get deeper into debt.

Doing a 0% balance transfer could allow you to avoid interest for 12 months or more. But if you don’t pay off the entire balance before the promotional period ends, the interest rate could rise significantly.

If you enroll in a debt management plan with a credit counselor, they may negotiate with your creditors to pay less than you owe, reduce your interest rate, or extend your repayment period. But if you can’t repay a debt management plan as agreed, your credit can suffer.

Risks of a debt consolidation loan

A debt consolidation loan can lower your credit scores in the short term. That’s because new credit applications cause your scores to dip. And if you use the loan to pay off a credit card and then close it, you reduce your total available credit, which causes credit scores to go down. (It’s better to keep a paid-off credit card open so you have more available credit in your name.)

However, if you make your new loan payments on time each month, your credit should recover fairly quickly from the slight hit it took when you opened the loan.

Should you get a debt consolidation loan?

A debt consolidation loan isn’t for everyone. I’d caution you to think twice before draining a retirement account to pay off debt or putting your home at risk with a home equity loan or line of credit.

And if poor spending habits are at the root of your debt, working with a qualified credit counselor to improve your financial habits may be more valuable than reducing your interest rate with a debt consolidation loan.

If you decide that a personal loan is right for you, Credible can help you compare personal loan rates from multiple lenders without hurting your credit.

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Need Credible® advice for a money-related question? Email our Credible Money Coaches at moneyexpert@credible.com. A Money Coach could answer your question in an upcoming column.

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About the author: Laura Adams is a personal finance and small business expert, award-winning author, and host of Money Girl, a top-rated weekly audio podcast and blog. She’s frequently quoted in the national media, and millions of readers and listeners benefit from her practical financial advice. Laura’s mission is to empower consumers to live richer lives through her speaking, spokesperson, and advocacy work. She received an MBA from the University of Florida and lives in Vero Beach, Florida. Follow her on LauraDAdams.com, Instagram, Facebook, Twitter, and LinkedIn.