Can You Consolidate Personal Loans Without Impacting Your Credit Score?

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Personal loan debt consolidation involves combining multiple debt balances such as vehicle loans, credit card debt, existing personal loans, and other similar financial obligations into one new loan.

In most cases, there will be some impact on your FICO score, but in the long run, it may be a good move if you’re disciplined and make payments on time.

Why You Should Consolidate Your Debts

Debt consolidation makes the most sense when you can improve your debt situation with a lower monthly payment, a lower interest rate, a shorter payoff term, or a more secure loan.

Consolidating your debt can save you money while also simplifying your payments. If you manage many accounts, you’re more likely to make a mistake that could ding your credit when you miss a payment or you’re late. Paying multiple lenders each month is not only a hassle, but it can also be depressing to face bills several times a month. 

You can consolidate all different kinds of debt using a personal loan. But first, you’ll want to determine if it’s your best option.

Factors That Impact Your Credit Score

To better understand why you might want to consolidate your debts, it’s a good idea to understand better how your credit score is determined. There are five factors, and each is weighted as part of the process to generate your score. The five factors include:

Your Payment History defines how consistently you’ve made your payments on time. Lenders don’t like to see late payments, debt settlement issues, or other poor credit habits. This is the most important contributor to your credit score. Weighted 35%.

Amounts You Owe is the existing debt you currently owe. The lower the amount of outstanding debt as an overall mix of your credit limit, the higher your credit score. Weighted 30%.

Length of Your Credit History is based on the length of time you’ve had credit accounts open in your name. A more extended credit history can help you with a good credit score. Weighted 15%.

New Credit You Apply For are credit inquiries. Every time you apply for credit, your score goes down slightly. The one exception is when you’re shopping for a mortgage, student loan, or auto loan. Credit scoring models only count one inquiry if your comparison shopping with multiple lenders takes place in a 14 to 45-day period. Weighted 10%.

Types of Credit You Use can increase your score if you responsibly use different types of credit, such as installment and revolving debt. Weighted 10%.

Pros and Cons of Personal Loan Debt Consolidation

There are several benefits to using a personal loan to consolidate debt.

You could boost your credit if a debt consolidation loan improves the profile of your credit score factors. A personal loan makes it easier to pay your debt on time, and you may be able to structure a personal loan so that your credit utilization rate goes down, driving your credit score up and improving your creditworthiness.

You could reduce your blended interest rates from several accounts into a single and lower personal loan rate when you refinance, saving a ton of money on interest payments. 

Sometimes, you may take a loan out at a variable rate. When interest rates rise, you’re at the mercy of market forces and potentially high interest rates, and you could get slammed with bigger loan payments you may not be able to handle. When you get a fixed-rate personal loan, you know exactly what your repayment terms will be for the life of the loan. That creates much-needed financial stability while avoiding bad credit situations in the long run. 

Be sure to watch for fixed-rate loans that offer introductory teaser rates. You can lock in an incredibly low rate for a year or so, but when the ongoing rate kicks in, you could also be greeted by a nasty surprise. Make sure you find out the maximum rate you could be charged for your consolidation loan.

Instead of several open-ended accounts, when you take out a personal loan, you agree to repay that loan on a set schedule specified in your loan agreement. You know your loan term at the start, so you’ll know exactly when you’ll become debt-free if you pay on time. However, check and see if your lender will charge you a prepayment penalty if you pay off the loan early.

There are also some downsides to a consolidation.

There’s no guarantee that a personal loan will definitely have a lower interest rate than all the debt you pay off. If you consolidate any original debt with a lower interest rate, you’ll raise the costs of repaying it. You need to weigh the overall impacts of using a personal loan and see if the global impact is a net positive or net negative on how much you’ll ultimately pay.

Also, even if you lower your interest rate, there’s a chance your personal loan could cost you more if you stretch out your repayment period for too long.

Sometimes you have to pay to take out a personal loan. A lender may charge you an application fee, origination fees, or prepayment penalties if you pay off your loan early. You’ll need to ask your lender about those fees and then factor them into your overall loan costs.

Some personal loans are secured loans, meaning you must put up collateral to guarantee the loan. This might be the case with a HELOC, where you pledge your home against the loan you take out. That creates added risk you’ll have to consider as part of your overall decision.

Last but not least, if you’re not disciplined in managing your personal loan repayment, you could end up deeper in debt. 

For example, when you pay off credit cards using the proceeds of a personal loan, you free up your line of credit. If you use these cards again and can’t pay off the balance, you could end up owing your original creditors again, leaving you in horrible financial shape.

How Debt Consolidation Affects Credit Scores

When you consolidate debt, you pull put in motion several changes that help or harm your credit.

For example, when you execute a new credit application or a balance transfer credit card, the lender will perform a hard inquiry on your credit. While this isn’t a big hit (your overall score will drop a few points for several months), it does show up on your credit report. Hard inquiries can affect your credit score for one year.

If approved and you open a new credit account, your credit score also decreases temporarily. Lenders see new credit as a new risk, so your credit scores usually have an additional temporary dip when taking out a new loan.

Opening a new line also lowers the average age of your credit as monitored by credit bureaus.  This is counter to established accounts which, over time, show a positive history of on-time debt payments, causing your credit scores to rise. Remember that this temporary drop may be countered by overall lower credit utilization, sometimes referred to as a debt-to-income ratio.

Your credit score could also be negatively impacted if you close your credit accounts after consolidating the balances. It’s best to keep accounts open but not use them so that your credit age remains high and your utilization ratio drops. Also, if you only have revolving credit like credit cards, adding a personal loan for debt consolidation can improve your credit mix and boost your score.

Options For Consolidating Your Debt

Consider these options as ways to consolidate debt in addition to possibly taking out a personal loan.

  • Take out a home equity loan, but only if you’re sure you can repay the loan since your home will be used as collateral.
  • Apply for a favorable balance transfer credit card.  Many offer 0% APR introductory offers.
  • Take additional cash out of refinancing your vehicle.
  • Look into a retirement account loan but be careful to pay it back according to the retirement plan’s rules, or you may face taxes and penalties. You’ll often get a lower rate than with other types of debt.
  • Use a debt management plan with a Certified Credit Counseling Agency. A credit counselor is a great ally to help you with debt relief issues and personal finance challenges.