Lots of people opt for debt consolidation as a way to better manage their finances. But does debt consolidation affect your credit score? The key thing to remember is that any new loan will probably affect your credit score. But in the long term, providing your debt consolidation loan is paid off on time, it will actually have a positive impact on your overall credit score. Below, we look in detail at how debt consolidation might affect your credit score.
What is debt consolidation?
A debt consolidation loan enables you to bring all of your debts into one place and make regular repayments to one lender. For instance, if you have three credit card bills outstanding, you can take out a personal loan to repay each of the credit card debts and then focus only on repaying the loan that you’ve just taken out. If you’re paying a high rate of interest and are managing multiple payments, debt consolidation may be a good option for you.
The pros and cons of debt consolidation
If you’re looking to benefit from debt consolidation, the pros certainly outweigh the cons:
- Debt consolidation can undoubtedly save you money. Just make sure you calculate the terms of the new loan correctly.
- Budgeting becomes easier when you’re making repayments to one lender.
- Debt consolidation offers clear repayment terms and allows you to get back on track with your debt repayments.
- In the long run, you can build up a good credit rating if you make your debt consolidation repayments on time.
Two potential drawbacks include:
- Your credit score might take a hit in the short term.
- You might struggle to get another loan with a good rate of interest if your credit score is low to start with.
Credit score explained
When a lender is deciding whether to provide you with a loan, they want to know if you’re likely to pay it back. This is where a credit score comes in. Supplied by credit bureaus, a credit score gives lenders a reasonable idea of your credit history, which will help them decide if they should approve your loan application. Your credit score will be affected by loan repayments in the past, as well as how long you’ve lived at your current address. Certain actions, such as missing a loan repayment, can count against you and negatively impact your credit score while repaying credit on time will work in your favour.
How does debt consolidation affect your credit score?
In the short term, your credit score might take a hit when you apply for a debt consolidation loan. When you shop around for a loan, lenders will run either a soft or hard credit search, depending on their policies. If they perform a hard credit search, it will appear on your credit history. If you have multiple hard credit searches against your name, it doesn’t look good to other lenders. So, make sure the lender that you’re applying to performs a soft search when looking into your credit history. Another potential impact on your credit score is that closing old accounts isn’t necessarily a good thing. For instance, closing credit cards will lower your credit utilisation ratio, which will also lower your credit score.
In the long run, debt consolidation is likely to have a positive impact on your credit score. This is because lenders like to see borrowers who are on top of their repayments, and debt consolidation is an example of sound financial planning. Debt consolidation may also enable you to pay off your loans faster, which can also raise your credit score.
Debt consolidation FAQs
How long does debt consolidation remain on your credit file?
A debt consolidation loan will remain on your file for a considerable amount of time, but if you’ve made your repayments on time, it will help your credit score in the long run.
Can I use my credit card after a debt consolidation loan?
While you can still use your credit card after a debt consolidation loan, you risk recreating the problem that you’ve just solved. So, it’s best to rein in your credit card spending until you’ve paid back the debt consolidation loan.
Will a debt consolidation loan affect my home purchase?
If you have lots of outstanding forms of credit, a mortgage provider may not be willing to lend you the money you need for a home. But remember – a debt consolidation loan is a good way to get your repayments back on track, so it will actually help your chances in the long run.
Apply for a debt consolidation loan
If you’re hoping to take out a debt consolidation loan to improve your financial management, you can apply to a lender like Koyo Loans. Koyo offers unsecured personal loans that you can use to consolidate your debt, helping you wrestle back control of your finances and work your way out of debt.