How to Consolidate Credit Card Debt Without Hurting Your Credit

What Is Debt Consolidation?

Debt consolidation is the process of combining several existing debts like high-interest credit card balances into a single debt. You can do that with a debt consolidation loan or other personal loan, by transferring multiple credit card balances to one credit card, or by taking out a home equity loan or line of credit (HELOC). Each of these methods could potentially benefit your credit score—or, if you aren't careful, hurt it if you are late making payments or close old accounts prematurely. Here is what you need to know if you're considering consolidating your credit card debt.

How Debt Consolidation Impacts Credit Scores

Debt consolidation can have both positive and negative effects on your credit score. In the short term, consolidating debt can hurt your credit score somewhat because: 

• If you apply for a personal loan, credit card, or home equity loan or HELOC, lenders will run a hard inquiry on your credit reports. This will temporarily ding your credit. 
• Likewise, if your application is accepted, that new loan or credit card will also temporarily ding your credit because they're new. New credit accounts are one of the factors used to determine your credit score, accounting for 10% of FICO scores, the most widely used type.
• If you close your credit card accounts following debt consolidation, this could harm your credit score by increasing your credit utilization ratio. That's the amount of debt you currently have outstanding compared to the total amount of credit you have available to you. Your credit utilization ratio is a major part of FICO's "amounts owed" category, which accounts for 30% of your credit score.
• If you have any missed or late payments during the debt consolidation process, this could damage your credit score even more severely. Payment history is the single largest factor (35%) affecting credit scores.
  

Often, though, debt consolidation will benefit your credit score in the long run: 

• Having one payment can make it easier to manage and pay on time, which will improve your credit score. 
• If you obtain a lower interest rate on the new loan or credit card than you were paying before, you should be able to pay your debt down faster, lowering your credit utilization ratio and improving your credit score—and saving you money on interest over time.
• Similarly, the new credit account will increase your available credit, also improving your credit utilization ratio (as long as you don't rush to close the old accounts). 

Debt Consolidation Options That Don't Hurt Credit

You have a variety of options for consolidating your credit card debt. None of these will hurt your credit in the long term if you're conscientious about making your payments.

Credit card balance transfers

Many credit card companies offer cards that allow you to transfer your existing card balances to a new card. Balance transfer credit cards typically have a zero- or low-interest rate for a certain promotional period, say 12 months. That can save you money on interest and help you pay off your debt faster. 

When transferring balances, the credit card company typically charges a balance transfer fee, often 3% to 5% of the amount transferred. So if you transfer $3,000, for example, you could pay up to $150.

To maximize savings with a credit card balance transfer, you will want to make sure to pay off the card before the promotional interest rate expires and the new, and likely much higher, rate kicks in.

Using a loan to consolidate credit card debts

If you're not inclined to take out a new credit card, or don't qualify for a good one, you might consider applying for a loan to consolidate your debts. To get the most benefit, you'll want to shop around for an interest rate that's significantly lower than you're currently paying on the debts you're planning to consolidate.

Your options could include a personal loan or a debt consolidation loan. Both are forms of personal loans, but debt consolidation loans are intended for that specific purpose.

If you own a home you might be eligible for a home equity loan or line of credit (HELOC). The former comes in a lump sum that you pay off over time, the latter as a credit line that you can borrow against as needed. One caveat with both home equity loans and HELOCs is that they are secured by your home and your lender could foreclose on it if you are unable to keep up with the payments.

By contrast, most personal loans are unsecured, as are most credit cards.

Debt management plans

Debt management plans are not the same as debt consolidation, but they can achieve a similar result. A nonprofit credit counseling agency will help you and your current creditors come to an agreement that typically includes lower interest rates. You then make one monthly payment to the agency, which, in turn, pays your creditors.

Depending on how much you owe, it could take between three and five years to pay off your debt with a debt management plan. According to the National Foundation for Credit Counseling (NFCC), participating in a debt management plan won't harm your credit score. "Though there will be a note in your credit report that says you're enrolled in a debt management plan, it's not something FICO uses when determining a credit score," the NFCC says.

Overhauling your budget and spending habits

The easiest way to minimize harm to your credit score and save money on fees when consolidating debt is to make a budget for paying off your debt and sticking to it.

Look for opportunities to trim optional expenses, such as dining out and entertaining, and reduce required ones, such as housing. Also, consider your options for earning more money, such as working a second job or selling some possessions you no longer need. Apply those funds to your debt to pay it off faster.  

Factors to Consider When Consolidating Credit Card Debt

While there are several methods of debt consolidation, not every method is the right choice for every situation. So consider the following factors before choosing your debt consolidation plan. 

Interest rates and fees

Compare the interest rates and fees associated with each debt consolidation method to see which ones offer the best savings. When considering interest rates, keep in mind that the lowest rate may not offer the best savings. While one method may have a lower interest rate than another, if the payment term is longer, you could pay more in interest over time compared to a higher rate for a shorter term. 

Repayment terms and duration

Check to see how long each method will take to pay off your debt. For example, a personal loan might take three years or more. If you have a credit card balance transfer offer for 18 months, that might seem like a better option, but it will be only if you are able to pay off the balance within that 18 months. If you can't, you may end up paying more in interest on the credit card than you would on the loan. 

Another factor to consider are the repayment terms. With a personal loan, check to see if there is a prepayment penalty if you want to pay off the balance early. That penalty could negate any savings you could receive by paying the loan in full before the due date.  

Impact on credit utilization and credit mix

As mentioned, credit utilization contributes to 30% of your credit score. FICO's "credit mix" category, which rewards you for having more than one type of credit, such as a credit card, a mortgage, and an auto loan, accounts for another 10%.

If you transfer your credit card balances to a single credit card or pay them off with a personal loan, this could reduce your credit utilization, which is good for your credit score. However, if you close those credit card accounts, that could harm your credit score by increasing your credit utilization ratio. In addition, if you close all of your credit card accounts and replace them with a personal loan, you'll have less of a credit mix, which might also have a negative effect. 

That said, as you pay off your debt, your credit score will recover. But it may take a little time.  

Tips for Consolidating Credit Card Debt Without Hurting Credit

Try these practical tips for successfully consolidating credit card debt without harming your credit:

• Keep old credit cards open. (But try not to use them.)
• Pay off balance transfers quickly.
• Avoid taking on additional debt.
• Make on-time payments. 

Common Pitfalls to Avoid When Consolidating Credit Card Debt

When consolidating credit card debt, aim to avoid these common mistakes:

• Falling into a cycle of more debt. Once you pay off your credit cards with a debt consolidation loan or by transferring the balances, don't use those cards again until your previous debt is paid in full. 
• Closing old credit card accounts. As mentioned, this will harm your credit score. 
• Missing payments or defaulting on consolidation loans. This could not only lead to hefty late fees and increased interest rates, but it also will damage your credit score. Payment history is the most important factor when determining your credit score. 
  

The Bottom Line 

Consolidating your credit card debt to make it more manageable and less expensive, and to pay it off quicker, is often worth the time and effort. There are several different ways to go about it, and it's important to compare them before you proceed. If you do it right, you may enjoy the added benefit of a strong boost to your credit score.