Does debt consolidation affect your credit score?

What is debt consolidation? 

Debt consolidation is the process of moving some or all your existing debt into one place, such as a debt consolidation loan, or credit card. This could mean one monthly repayment to one lender.

You may be able to get a lower interest rate than you’re paying on your existing debts. However, you could end up paying more interest overall if you spread the repayments over a longer timeframe.

Whether debt consolidation is right for you will depend on your eligibility and individual circumstances.

What are the different types of debt consolidation? 

There are three main ways to consolidate debts: 

1. Take out a debt consolidation loan to clear your current debts 
2. Move your existing credit card balances onto a low or 0% interest rate balance transfer credit card (a balance transfer fee may apply)
3. Remortgage your home with additional borrowing and use these funds to pay off your existing debts

Will debt consolidation improve my credit score? 

While consolidating debt won’t improve your credit score on its own, your rating may improve if you use your new credit card or loan responsibly.

If you’ve been struggling with debt for some time, it’s understandable that you may have missed payments or made some late. These missed payments might have left you with a less-than-perfect score that limits your chance of being accepted for credit.

Always paying your new loan or credit card on time can boost your credit score. Plus, it shows lenders that you are a reliable borrower. 

Also, paying off credit cards with a loan can reduce your credit utilisation ratio. In turn, you may see your credit score go up. Your credit utilisation ratio is the total amount of credit you have available on credit cards versus how much of it you use.

Does debt consolidation hurt your credit score? 

New credit applications can affect your rating

Your credit score may dip temporarily when you apply for finance, and when you take out a new line of borrowing. This is the case whether you are consolidating debt or not.

Each time you apply, the lender will conduct a hard search of your credit report to see how well you have managed your finances in the past. This will be visible for other lenders to see for up to 12 months. Too many hard searches at once can suggest to lenders that you are in financial difficulty. As a result, they may question your ability to repay any future credit.

So, it's best to shop around using eligibility checkers instead of making multiple applications. These checkers can show your chances of approval, without affecting your credit score.

Closing consolidated credit cards can impact your score

If you are going to consolidate credit cards, it might be worth keeping them open afterwards (as long as you don’t spend on them). Otherwise, your credit score may be affected.

Closing credit cards can temporarily reduce your credit score by:

• increasing your credit utilisation ratio – the percentage of available credit you’re using may go up when your total credit card limit goes down. This could make you seem riskier to lenders.
• reducing the average age of your open accounts – having the same accounts for a long period of time suggests that you can manage them well.

Missed payments can damage your score

Any missed payments will stay on your credit report for six years. This can impact your credit score and ability to get approved for finance in the future. Late fees may apply.

Also, if you miss payments on a secured consolidation loan, your home could be at risk of repossession, as the loan is tied to your property. There is no risk to your property with unsecured or personal loans.

Read on to find out about the pros and cons of secured loans.

Can I consolidate debt without affecting my credit score? 

If you want to clear your debt without affecting your credit score, you could:

• use any available cash savings to pay off your debts
• create a new household budget to increase the amount you’re able to repay each month
• pay your debt in order of highest interest rates first, to make the remaining payments more manageable.

If you’re struggling with debt, you can access free financial advice and support from a professional debt specialist. Visit Money Wellness, StepChange, Citizens Advice, National Debtline, or MoneyHelper to find out more.