Credit card debt is a serious issue. The average cardholder in the U.S. has a balance of $5,234. According to the Federal Reserve, the average interest rate on credit cards is over 15.00%, which can cause your debt to spiral out of control quickly.
A debt consolidation loan can help you get back on track and save money over time. But do debt consolidation loans hurt your credit score? Here’s what you need to know.
What is a debt consolidation loan?
Credit cards often have high interest rates. If you only make the minimum payment due every month, it can take years to pay off your debt. Worse, you’ll pay far more than you initially charged in interest fees.
If you have high-interest debt, it can feel like making progress is impossible. So much of your payment goes toward interest charges that the principal barely budges. Getting discouraged is easy.
That’s where debt consolidation loans can help. A debt consolidation loan is a personal loan you take out to cover the cost of your current credit card balances and other forms of debt. It typically has lower interest rates than credit cards, and you have a fixed monthly payment and repayment term.
According to Thomas Nitzsche, a credit educator with Money Management International, there are several advantages to using a debt consolidation loan, including getting a lower interest rate, having one simple payment, and being able to pay down your debt faster. With a lower rate, more of your payment goes toward the principal instead of interest.
Do debt consolidation loans hurt your credit score?
Although debt consolidation loans can be helpful, make sure you understand how taking one out can affect your credit score. You’ll likely experience a decrease when you first apply, but then you should expect to see your score improve.
“As with any other loan, there will be a ding to the credit when you apply due to the hard-pull credit inquiry,” said Nitzsche. “Once transferred, freeing up credit limits on multiple accounts and making regular on-time monthly payments to the consolidation loan (and any other outstanding debts) should help the consumer improve their credit over the duration of their repayment.”
One factor that the credit bureaus look at when determining your credit score is your debt-to-income (DTI) ratio, or how much of your income goes toward debt payments every month. With just one loan and one monthly payment under a consolidation loan rather than multiple credit cards and monthly bills, your DTI ratio will likely improve. Plus, you can pay off the debt faster, further improving your score.
But keep in mind that making all your payments on time is essential.
“As with any other line of credit, if you fail to make payments each month there will be negative credit impact,” said Nitzsche.
What to consider before taking out a consolidation loan
Debt consolidation loans can be a useful tool in repaying your debt. But they’re not a surefire approach for everyone.
According to Nitzsche, one of the biggest problems he sees with clients who take out consolidation loans is that they don’t change their spending habits. Over time, they build up a credit card balance again and have to repay both the credit cards and consolidation loan.
“Often, this is coupled with a lowered credit score, making it impossible for them to consolidate again,” said Nitzsche.
If you decide to take out a debt consolidation loan, make sure you complete the following steps:
- Create and stick to a budget: A debt consolidation loan only works if you address the root cause of the problem that got you into debt in the first place. Create a budget and stick to it to avoid overspending and racking up debt again.
- Stay away from credit cards: While you’re repaying the consolidation loan, try not to use your credit cards. Focus on paying in cash to avoid juggling both loan payments and credit card bills.
- Find ways to make extra payments: Try to pay off the loan as fast as possible to save more money. By cutting your spending and boosting your income with a side hustle, you can get rid of your debt ahead of schedule.
Taking charge of your debt
Now that you know whether debt consolidation loans hurt your credit score, you can come up with a plan to tackle your debt. If you’re ready to make changes to your spending habits and commit to a repayment strategy, getting a debt consolidation loan can be a smart move.
If you’re ready to apply, here are some of the best debt consolidation lenders.
Interested in a personal loan?Here are the top personal loan lenders of 2018!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.16% to 35.89%. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at time of application. The origination fee ranges from 1% to 6% and the average origination fee is 5.49% as of Q1 2017. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months or longer.
7 Important Disclosures for Earnest.
8 Important Disclosures for Avant.
* The actual rate and loan amount that a customer qualifies for may vary based on credit determination and other factors. Funds are generally deposited via ACH for delivery next business day if approved by 4:30pm CT Monday-Friday. Avant branded credit products are issued by WebBank, member FDIC.
** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
** Accept your loan offer and your funds will be sent to your bank via ACH within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes this transaction. From the time of approval, funds should be available within four (4) business days.
|7.73% – 29.99%||$1,000 - $50,000||Visit Upstart|
|6.26% – 14.87%1||$5,000 - $100,000||Visit SoFi|
|6.99% – 35.97%*||$1,000 - $50,000||Visit Upgrade|
|8.00% – 25.00%2||$5,000 - $35,000||Visit Payoff|
|4.99% – 29.99%3||$10,000 - $35,000||Visit FreedomPlus|
|5.99% – 18.99%4||$5,000 - $50,000||Visit Citizens|
|15.49% – 34.49%5||$2,000 - $25,000||Visit LendingPoint|
|6.16% – 35.89%6||$1,000 - $40,000||Visit LendingClub|
|6.99% – 18.24%7||$5,000 - $75,000||Visit Earnest|
|9.95% – 35.99%8||$2,000 - $35,000||Visit Avant|