If you’ve been in financial trouble and want to get out of debt, you may be considering applying for a consolidation loan to help you. A debt consolidation loan will afford you a lump sum that allows you to pay off all your debts at once and be left with only a single loan to pay off. But what ripple effect does debt consolidation have on your credit score? Here are a few things you’ll see happen.
Your credit utilization rate will change
Your credit score is based on a few variables, but there are two that are weighed more heavily than the others: your credit utilization rate and the number of late payments you’ve made.
Credit utilization is a calculation of the amount of credit used every month against the total credit you have available. For example, if you have $100,000 in credit but carry a balance of $30,000, your Credit Utilization would be 30%. The three major credit bureaus recommend keeping your utilization under 20% for the best credit score.
When you pay off credit card debt with a consolidation loan, your utilization rate will go down as the total amount of credit you have available increases. Normally, this is a good thing for your credit score, but it’s important not to fall back into old habits and see that available credit as “extra” money to spend. Otherwise, you’ll end up having to pay off those balances plus your consolidation loan.
You’ll have a new hard pull on your record
Whenever a bank or lender processes a credit or loan application, they’ll do what’s called a “hard pull” on your credit report. These hard pulls are recorded and typically stay on your credit report for 5-7 years. Your score may be affected by this, but by how much depends on how many pulls you’ve already had on your report. Having too many pulls will make lenders think you’re desperate and they’ll be less likely to approve you for new credit cards, loans, or mortgages.
Your score may change a few times
Your credit score will fluctuate while your debt moves around from credit cards to loans, so expect to see it go up and down the first few weeks while things settle. Depending on whether or not your loan is reported to the credit bureaus, your score may reflect the new loan and list the amount of debt you owe, even if it’s not directly related to your credit utilization.
The bottom line
Debt consolidation can help you regain some control of your financial future, but it’s important to note that it’s not a magic bullet. You’re still responsible for making monthly payments on all your debts and understanding how your new loan will impact your credit score. Debt consolidation is only a tool, but it can be a helpful system that streamlines your debt payoff and gets you out from under your creditors as quickly as possible.
