How debt consolidation loans can impact your credit

Quick insights

• Debt consolidation loans are used to combine multiple high-interest payments into a single, fixed payment (ideally with lower interest).
• Debt consolidation loans can both help or hurt your credit in certain ways, depending on your current credit situation and the way you manage repayment over time.
• Debt consolidation may not be for everyone; you may consider other ways of debt management such as the debt snowball or debt avalanche methods.

Even with a carefully considered budget, unexpected expenses can snowball into debt that becomes difficult to manage. Especially when debt is spread across multiple different lines of credit, it’s easy to feel surrounded. For some, a debt consolidation loan can be the answer; these loans may provide a lower annual percentage rate (APR) and can combine many bills into a single monthly payment. 

You may be wondering if a consolidation loan is bad for your credit. In this article, we’ll explain how debt consolidation loans work, the initial impact you may see on your score and some of the potential long-term effects of debt consolidation loans. We will also provide a few alternatives to debt consolidation loans for you to consider.

What is a debt consolidation loan and how does it work?

Debt consolidation loans are a type of personal installment loan, typically used to pay off high-interest loans, credit cards and other debts. Once you’re approved for a debt consolidation loan, you receive funds that can be used to repay your debts. You’ll then repay the debt consolidation loan on a monthly basis, following a set schedule with pre-determined payments. Note: Chase does not offer debt consolidation loans.

Loans like these tend to have a lower APR than other forms of debt, which can make them more affordable to pay down over time. For comparison, the average APR for personal loans in 2024 was 12.27% according to the Federal Reserve, while the average for credit cards was 21.58%.fed-reserve-consumer-credit-25 This means that interest on a credit card could accumulate almost twice as fast as it might with a debt consolidation loan.

Applying for a debt consolidation loan

Loan applications typically require you to provide personal details, such as contact information, your Social Security number, your employer’s name and your current income. You may also need to provide a list of all debts you plan to consolidate and their total amounts. The lender will likely assess your credit (conducting a hard credit check) and your debt-to-income (DTI) ratio, among other factors to determine your creditworthiness. Adding a co-signer to your loan may improve your odds of approval if your credit or income is a bit low.

The initial credit impact of a debt consolidation loan

Paying off your debt can be appealing, but is a debt consolidation loan bad for your credit in the short-term? You may see some changes in your credit, but the answer is somewhat nuanced. 

Pro: Improvement in credit utilization ratio

Credit cards are a form of revolving credit, meaning that you can draw money from them and repay them over and over. The amount of credit you use against your total available credit at a given time is measured on your credit report as credit utilization. If you’ve consistently used 30% or more of your available credit at once, this is likely to have had a negative impact on your score. When you repay the debt on these cards, such as with funds from a debt consolidation loan, your credit utilization may go down and consequently your credit score may improve.

Con: Dip from a hard credit check

When you apply for a new line of credit, the lender generally conducts a hard credit check to view your current score and recent credit activity. This helps the lender judge your creditworthiness, or the likelihood of repaying the loan, and can impact both approval and the rates you’re presented with. Hard credit checks may temporarily impact your score. This is different from a soft credit check, which does not impact your credit score.

Overall, how badly debt consolidation helps or hurts your credit will depend on your unique situation.

Next, let’s consider if debt consolidation loans are bad for your credit over the long-term.

The long-term credit impact of a debt consolidation loan

Whether or not a debt consolidation loan is bad for your credit score in the long-term largely depends on how you manage it and the new financial habits you create.

Opportunity: Building a positive payment history

With every line of credit, including a debt consolidation loan, there’s an opportunity to improve your credit score by making timely payments. A debt consolidation loan you take out may last two or more years, with monthly payments of a fixed amount that could be easier to budget for than scattered and accumulating debt. If you make every payment on time, it may have a positive impact on your credit score and leave you in a better position for future financial opportunities.

Opportunity: DTI ratio management

If your debt consolidation loan has a lower interest rate than your current debts, you may owe less each month. This could increase the percentage of your income spent on debt, which is ultimately what DTI assesses. Having a low DTI can help improve your chances of approval for other lines of credit or loans (including mortgages) or possibly result in better rates.

Potential risk: Accruing debt

A debt consolidation loan doesn’t prevent you from accumulating debt. Once you’ve used this type of loan to repay your current debts, you still need to pay it back. If you have difficulties in doing so, you may find yourself in an increasingly stressful position with a negative impact on your credit score.

What to consider before applying for a debt consolidation loan

In addition to the evaluating how debt consolidation loans will affect your credit, you may also want to keep the following elements in mind when considering this type of loan:

• Compare interest rates: While the interest rate a lender can offer isn’t the only factor to consider, securing a low rate is necessary to make the move worthwhile. The wider the gap between the rates on your current debts and the consolidation loan, the more money you will be able to save each month while repaying your debt.
• Financial stability and budgeting: While a debt consolidation loan can help wrangle dispersed payments to multiple lenders, it’s important that you have a solid plan in place to repay the new loan. Realistically assessing your budget and making room (if needed) to repay the loan can help ensure you see reductions to your debt, rather than adding to it.
• Long-term financial goals: Consider how a debt consolidation loan fits into other long-term financial goals that you have. 

Alternative strategies for managing debt

While you decide if a debt consolidation loan is right for you, you may also want to consider other ways to manage your loans, such as:

• The debt snowball and debt avalanche methods, which present different strategies to repay debts in a specific order, without consolidating.
• Credit counseling and debt management plans, which can help you structure your repayment without taking out a new loan; however, these services may incur fees.
• Balance transfers, which means moving your balance from one credit card to another with a lower interest rate.

In conclusion

If you’re struggling to manage monthly payments to multiple creditors, a debt consolidation loan can help simplify your bills and potentially reduce how much interest you owe. As explained in this article, consolidating debt may impact your credit in certain ways, but successful management of a debt consolidation loan can help improve it over time.

If you don’t know your credit score currently, or want help monitoring it, Chase Credit Journey^® is a free online tool that helps you do just that, as well as access your score anytime. Anyone can sign up, including those who are not Chase customers.