When I was in mortgage lending, the most common reason for lower-than-expected credit scores was high credit card balances. Paying the balances off or down was usually the fastest path to a score improvement.
Since the new year began, my inbox and social media feeds have been inundated with debt consolidation loan offers. This makes me wonder: Can a credit card consolidation loan help your credit score?
When a colleague and I searched the social media universe for the answer, we found something surprising: Many personal finance influencers advise against them. But why would they advise against swapping revolving debt that can tank credit scores with credit score-friendly installment debt?
To get the answer, I interviewed colleagues who took out personal loans to consolidate their debt and dug into some TransUnion data. The results were somewhat unexpected.
How a personal loan helped a Bankrate credit card expert raise her score
Seychelle Thomas, a credit card writer at Bankrate, decided to get a personal loan to consolidate her credit card debt in 2024. Her efforts resulted in a big jump in her credit score, pushing her into the excellent credit tier in about a month.
“When I applied for the loan on October 8th, my credit score was 717. Since I already had good credit, improving my score wasn’t my main focus — just a pleasant side effect of saving money on interest.”
Seychelle thought her score might improve by 20 to 30 points, which it did, hitting 742 at the end of October. She decided to get rid of some cards that weren’t worth it and applied for a new card on October 28, 2024 with a $15,000 limit. That’s when her scores took off.
“By November 7, 2024, my credit score hit 801 for the first time ever. So, in one month, my score improved by 84 points with the help of that personal loan.”
The ways paying off credit card debt helps your credit score
Most people know that paying your bills on time carries the most weight when it comes to your credit score. According to the FICO scoring model, it makes up 35 percent of your credit score.
However, your credit utilization ratio is a close second, making up 30 percent of a FICO credit score — only a 5 percent difference from payment history. Reducing your credit card balances reduces this ratio and produces an almost immediate score improvement.
How much can your score improve from a debt consolidation loan?
According to an in-depth debt consolidation study by TransUnion, consolidating debt with a personal loan results in an average 18-point credit score increase at the time of origination. That increase also continues as the loan is paid off. The initial 18 points might not seem like a significant increase until you look at how 18 points could affect future credit eligibility:
- It could save you on mortgage closing costs. Home lenders add extra costs to your rate based on your credit score. For example, a score increase from 699 to over 700 could save you more than $1,200 on a mortgage to buy an average-priced home.
- It could save you 10 percent or more on a personal loan APR. A bump in your credit score from 629 to over 640 could result in a fair credit rating versus bad credit, dropping the average personal loan rate from above 30 percent to below 18 percent.
- Your homeowners insurance premium could drop substantially. An 18-point score increase could move you from a poor credit rating to average, saving you over $1,000 on the cost of $300,000 worth of homeowner’s dwelling coverage.
Bankrate tip
Credit experts recommend a credit utilization rate of no more than 30 percent. That means for every $1,000 of available credit, you should keep the balance below $300 to optimize your credit score.
Does debt consolidation hurt your credit?
Some debt consolidation scenarios could lead to a drop in your credit scores. Besides the initial dip from the hard inquiry caused by the lender pulling your credit, your credit utilization and length of credit history after the consolidation will also affect your credit score.
- Be careful about paying off and closing out credit cards. If you use credit cards regularly for bill-paying, rewards or cash-back incentives, make sure you adjust your spending if you reduce your available credit. For example, let’s say you spend $3,000 per month on $10,000 of available credit to max out your rewards and cash back, but plan to cut your available credit to $5,000. You’ll need to scale your spending to $1,500 to stay below the 30 percent credit utilization recommendation.
- Length of credit history. If you’re relatively new to the credit world, a new account could push the “average age of your open accounts” portion of your score down. This factor accounts for 15 percent of your credit score, and may have more impact on your debt consolidation efforts if you don’t have a lot of other open credit.
What to do if your credit score drops after a debt consolidation loan
Bankrate editor Daniella Ramirez and her husband took out a debt consolidation loan to pay off $10,000 of their credit card debt in August of 2024. They were frustrated by a drop in their score from 716 to 693 by December of that same year.
“The drop happened because we applied for a debt consolidation loan, which added a hard inquiry to our credit report. Plus, opening a new account can temporarily lower our score since it changes the average age of our credit accounts.”
Despite the credit score setback, Daniella and her husband are committed to their debt payoff plan. They’ve also changed their spending habits to avoid future credit card use.
“We’re currently using cash to cover our daily expenses and groceries. This helps us to stick to a budget and ensures we don’t overspend. Whatever money is left over after those essentials is directed toward paying bills and chipping away at any other debts.”
Why some personal finance experts may not be fans of debt consolidation
One troubling finding in the TransUnion study was that debt consolidation loans don’t seem to curb future credit card spending for the average consumer. Despite a 57 percent average decrease in credit card balances, within 18 months, the balances were back to pre-consolidation levels.
That may explain why influencers aren’t big fans of debt consolidation loans. Instead, they recommend a “charge-and-pay-in-full” strategy for credit card use. The problem with this strategy is that no matter how fast you pay your debt off, any balance could temporarily reduce your scores.
Debt consolidation loans are a credit-score-saving alternative for consumers who want to avoid having a maxed-out credit card and can’t afford to pay in full immediately.
Why Americans struggle to pay off their credit cards off with cash
The solution to having too much credit card debt might seem obvious: pay it off. However, looking at Americans’ savings habits and pay raise expectations reveals why this isn’t a realistic option for many households.
- The number of Americans without emergency savings is rising. Bankrate’s Emergency Savings Report shows that 27 percent of U.S. adults have no emergency savings as of May 2024, the highest percentage since 2020.
- A quarter of Americans would use credit cards to pay for a $1,000 emergency expense. The same report shows that a quarter (25 percent) of U.S. adults would use a credit card to pay for an unexpected emergency expense, such as $1,000 for an emergency room visit or car repair, and pay it off over time — up from 21 percent in 2024.
- The number of workers receiving pay raises is falling. The share of workers earning a pay increase fell to a three-year low of 20 percent in 2024, according to Bankrate’s Pay Raise Survey. Many earners fortunate enough to get a bump in pay said that the increase wasn’t enough to keep up with inflation.
If consumers don’t have extra cash for emergencies, they will not likely have enough room in their budget to pay off credit cards. A debt consolidation loan may be the only path in these scenarios to avoid the harmful credit score effects of carrying too much credit card debt.
Bottom line
While a debt consolidation loan has the potential to boost your credit score, it’s also an opportunity to change your spending habits. Any score improvement or financial benefit will be temporary if it doesn’t curb over-using credit cards in the future.
If you find yourself repeatedly turning to debt consolidation loans to clear out credit card balances, it might be time to seek some credit counseling.
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