How Debt Consolidation Affects Credit Score

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Debt consolidation is one possible method of dealing with unmanageable bills.
Debt consolidation is one possible method of dealing with unmanageable bills. (Image: credit 3d sign image by onlinebewerbung.de from <a href='http://www.fotolia.com'>Fotolia.com</a>)

It's not uncommon for people to get into debt to a level where it becomes hard to keep up with payments. Once someone gets to that point, finding a way out can be difficult. It is easy to get further and further behind. Debt consolidation is one way to deal with out-of-control bills. Debt consolidation programs bundle together your debts and you make one payment instead of several. Understanding all the potential hazards and benefits of a debt consolidation program, including the effect on your credit score, is important before you choose this option.

Debt Consolidation Loans

One form of debt consolidation is a loan. In general, using money from a consolidation loan to pay off other debts doesn't have any affect on your credit score. However, closing the paid off accounts could negatively affect your score. Part of your credit score is based on the length of time your accounts are open, so keeping older accounts open with zero balance has a positive impact on your credit score.

Debt Management Programs

Another form of debt consolidation is a debt management program. This differs from a consolidation loan because you pay off the debts over time. Various independent companies manage these plans. These debt management groups can often negotiate lower interest rates on accounts and other concessions--lower minimum payments for example--because of deals they've worked out with the credit companies. You consolidate your bills in that you pay one bill--to the debt management administrators--and they make the payments to your creditors on your behalf. Your payment to the program covers both pay down amounts for your bills and fees charged for the administration of the plan.

On Time Payments

You need to pay your plan on time. If you get a late payment to the consolidation administrators, your creditors will be paid late. That will lower your credit score. In addition, check the reputation of debt management companies before signing onto a plan. Make sure there are no complaints against the firm. Late payments can be detrimental to your credit score, with or without a debt management program.

New Credit

Once you sign onto a debt consolidation program, a notation about the program appears on your credit report. Anyone getting a copy of the report will see that you are enrolled in a debt management program. Generally, this will make it very difficult to get new credit issued. Since most programs also prevent new charges on current accounts, it effectively stops any credit use during the term of the debt management program.

Credit Score

Other than the notation that shows on the report, credit scores should be relatively unaffected by enrollment in a debt management program. Of course, that is based on the on-time payment caveat. Once you complete the program, generally three to four years, a notation will be added to the report showing successful completion. The effect of various accounts getting paid off during the course of the program can lead to a rise in your credit score.

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