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Does Debt Consolidation Hurt Your Credit?

Debt consolidation will likely hurt your credit in the short term, but it can drastically improve it in the long run if used correctly.

Chris Scott

Contributing Writer at Tally

February 9, 2021

The State of Credit 2020 report from Experian found that the average American credit card balance was $5,897 and that the average VantageScore credit score was 688. When you consider that the average credit card interest rate is above 15%, carrying a balance can add up quickly. 

Credit card balances not only cost you money but also reduce your credit score. A poor credit score makes it difficult to secure future lending, impacting your ability to do things like buy a home, rent an apartment or purchase a car. 

If you're looking to pay down debt as quickly as possible, one of the options you may consider is debt consolidation. Two of the most popular debt consolidation tools are balance transfer cards and personal loans. 

But, does debt consolidation hurt your credit? In this article, we'll detail both options and the impact they have on your credit so that you can determine which is best for you. 

What is debt consolidation? 

Debt consolidation is a way to refinance your debt by taking all your unsecured debts and combining them into one monthly payment. Let's say, for instance, that you have three different credit card accounts, each one carrying a balance. Having to track three different accounts, minimum payments and due dates increases the likelihood of late payments and penalties. 

To mitigate this, you consolidate the debt from these three cards into one place. The most common methods of debt consolidation are balance transfer credit cards and personal loans. 

Balance transfer credit card 

A balance transfer credit card is specifically for those who want to pay down debt they've accumulated on other credit cards. These cards often come with promotional 0% annual percentage rates (APRs), giving cardholders a grace period to pay down credit card debt without collecting additional interest. 

Many balance transfer cards offer the promotional APR for a period of 12 to 18 months for new cardholders. Cardholders transfer their debt from high-interest credit cards to the balance transfer card. 

Instead of having to pay the principal plus interest, cardholders now only need to pay down the remaining balance. When the promotional APR expires, the lender will begin charging interest on whatever balance remains. 

While balance transfer cards are an effective tool for debt relief, there is a catch. If you miss a minimum monthly payment on a balance transfer card with a promotional APR, the lender will charge a late fee and a penalty APR. This voids the promotional offer. Penalty APRs can be as high as 25%.

In addition, these cards come with balance transfer fees. The balance transfer fee is typically 3% to 5% of the total balance transferred. 

For instance, let's say that you have the following balances on three credit cards: 

  • $1,000 

  • $4,000 

  • $7,000 

You move all three balances to a balance transfer card. The total that you put on the new credit card is $12,000. The balance transfer card comes with a 4% transfer fee, equal to $480. This is added to the principal. Thus, your total balance to pay down is $12,480. If you pay this down before the 0% promotional APR period expires, you will not owe any interest. 

Do balance transfer cards hurt your credit? 

Yes, in some ways a balance transfer card can hurt your credit score, especially in the short term. But if used correctly, it will improve your score in the long term. 

Opening a balance transfer card requires lenders to look into your creditworthiness, just as they would if you were taking on any other type of new debt. The application results in a hard inquiry, which causes a short-term drop in your credit score. 

Furthermore, the new account will decrease your average account age. The average account age factors in all accounts associated with your credit history. The older your average account age, the higher your credit score. The new debt will automatically decrease your average account age. 

However, a balance card can improve your credit score as well. Making on-time payments and avoiding penalty APRs improve your payment history. 

Additionally, as you pay down your balance, you decrease your credit utilization. Your credit utilization is a measure of your credit used versus your total available credit. Lenders like to see your credit utilization ratio below 30%. 

As you pay down debt, you use less of your total available credit, thereby decreasing your credit utilization. So, although balance transfer cards may harm your credit in the short term, they may actually lead to a good credit score if they are used as part of an effective debt management plan. 

Personal loans

Another popular debt consolidation tool is a personal loan. Although a personal loan may not come with the promotional APR that a balance transfer card does, it should come with a lower interest rate than what you are paying on your existing credit cards. 

With a personal loan for debt consolidation, you combine multiple debts into a single loan. You then make fixed monthly payments for a predetermined period of time until you pay down the balance of the loan. The interest rate and amount of your fixed monthly payment are spelled out in the loan terms. 

Whereas balance transfer cards only work for credit card debt, personal loans are advantageous because you can roll any type of existing debt into them. This includes debts such as: 

  • Medical bills 

  • Student loans

  • Home equity loans (not mortgages) 

Typically, the total loan amount is equal to the amount of debt that you're looking to pay off. 

Do debt consolidation personal loans hurt your credit? 

Like a balance transfer card, a personal loan can both hurt and help your credit score. The hard inquiry required to open a new loan will cause a short-term dip in your score.

But, as long as you’re making on-time payments, a personal loan can improve your credit by helping you establish a payment history. 

They’re also advantageous because they allow you to diversify your credit mix. If you're a borrower who's only used credit cards for debt, adding a personal loan can help your credit score. Personal loans are considered installment loans, which is a different type of debt than a credit card.

Are there alternative options to consolidate debt? 

Another debt consolidation repayment option is a service like Tally. Tally is a credit card payoff app that extends you a line of credit. It allows you to combine multiple debt payments into one monthly payment so that you can pay down your debt in the most efficient way possible. 

This is thanks to the Tally Advisor, which is a robo credit counseling service. Tally Advisor suggests how much you should pay each month toward debt — based on things like your spending habits, credit limits, current balances and APR. It provides you with the support and guidance you need to become debt-free. 

Tally will help you improve your credit score in the long run, pay down debt quickly, and cut down on the total amount that you pay in interest. 

Final verdict — does debt consolidation hurt your credit? 

Debt consolidation is an effective tool to save on interest and pay down debt as quickly as possible. Different methods available include balance transfer credit cards, personal loans and credit card payoff apps. 

No matter which option you choose, you're bound to harm your credit score in the short term. All of these options require lenders to run a hard inquiry on your credit report, which will cause a short-term loss of a few points. Additionally, the new account will cause your average age of accounts to decrease, which will also impact your score. 

Besides that, if you practice good financial habits and make on-time payments, you'll quickly boost your credit score. Furthermore, paying down total debt improves your credit utilization ratio, another factor that can help increase your credit score. 

So, when used correctly, debt consolidation methods are excellent tools to help improve your credit scores. The short-term harm that you do to your credit report is well worth it if you make timely payments and end up paying down debt quickly.