How debt consolidation affects your credit score

Debt consolidation can simplify your finances and it may improve your credit score over time. However, it’s important to understand how it works and what its effects might be. This guide will help you navigate the process and decide if debt consolidation is the right option for you. With careful planning, debt consolidation could improve your financial situation in the long term.

What is debt consolidation?

Debt consolidation means combining multiple debts into one manageable loan or account. You might use a personal loan, balance transfer card, or specialised debt consolidation loan to pay off your existing debts.

This approach can make managing your finances simpler by turning several payments into just one. Over time, it may improve your credit score if handled properly. Here’s how it could affect your credit score:

How can debt consolidation help your credit score?

Lowering your credit utilisation ratio

Your credit utilisation ratio measures how much of your available credit you’re using. For example, if you have £5,000 of available credit and owe £2,500, your utilisation ratio is 50%.

By paying off credit card balances with a loan or a balance transfer to a card with a higher limit, your utilisation ratio decreases. A lower ratio is good for your credit score, as it shows you’re not overly reliant on credit.

Timely payments

When you consolidate your debts, sticking to the repayment schedule is crucial. Consistently paying on time builds a positive payment history, which is one of the most important factors for your credit score. It also demonstrates to lenders that you can be trusted to repay your debts.

How can debt consolidation hurt your credit score?

Increasing your credit utilisation ratio

If you use a balance transfer card with a lower credit limit or close older accounts after consolidating as part of a debt management plan, your credit utilisation ratio could increase temporarily. This might negatively impact your credit score. However, your credit utilisation rate will drop back down as you pay down your balances.

Reducing the average age of your credit accounts

Opening a new account could lower the average age of your credit accounts, which may briefly affect your credit history length. However, if you don't open new credit accounts unless you absolutely need them, that average will rise over time.

Hard credit checks

Applying for credit may involve hard credit checks, which can cause a slight and short-term drop in your credit score. Hard enquiries, however, only have a one-year direct impact on your credit score. That effect will lessen with time, and if you behave responsibly with your credit, you'll bounce back from the decline rather quickly.

What are best practices for debt consolidation?

Calculate your debts

Add up the total balances, interest rates, and monthly payments of your debts. This will give you a clear picture of your situation. You may also want to review your budget to see if you can afford to pay more than your current payments. See our guide on how to manage debt effectively for more information.

Compare consolidation options

Take the time to research and compare consolidation options from different sources. This will help you select the best choice to meet your needs. Take your time to compare offers for debt consolidation loans, balance transfer cards, or other solutions. Look at interest rates, fees, and repayment terms to ensure you pick the most affordable and suitable option.

Stick to your repayment plan

After consolidating your debts, commit to your repayment plan. Missing payments could undo any positive effects of consolidation. If you're on a debt management plan, it’s important to stick to the terms to avoid plan cancellation and returning to managing your debt alone.

Summary

Debt consolidation can simplify your finances and potentially improve your credit score by lowering your credit utilisation ratio and supporting a strong payment history. However, it may cause short-term impacts like hard credit checks and changes to your credit history length. By planning carefully, comparing offers, and sticking to a repayment plan, you can avoid common pitfalls and make consolidation work for you.

If you are worried about the impact of debt consolidation on your credit score, don’t be. The Central Trust team are here to support you and will always aim to get you the loan which is best suited for you and your financial situation.

Ready to take control and simplify your debts? Call free on 0800 980 6273 to speak with one of our friendly advisors today. Let us help you achieve financial peace of mind.

THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.