Credit Sesame discusses the relationship between debt consolidation and credit scores. Consolidating debt can simplify payments, but it’s important to understand its impact on your credit score.
Recent news has shown that Americans’ debt struggles are growing. Debt balances are rising, and more and more households are falling behind.
Much of the problem comes from credit card debt. This debt carries exceptionally high interest rates, which is both bad news and good news. The expense of those high rates adds to the difficulty of keeping up with this debt. However, consolidating those debts also represents an opportunity to save money.
Still, consumers should understand that debt consolidation and credit scores are closely connected. If handled the wrong way, consolidation can make the problem worse instead of better.
High-interest credit card debt continues to cause trouble
A recent report from TransUnion showed that the average credit card balance grew in 2024, rising from $6,360 to $6,580. Other forms of consumer debt are rising, too, so why single out credit card debt?
Credit card rates are typically much higher than other common forms of consumer debt. According to the Federal Reserve, as of the end of 2024, the average rate charged on credit card debt was 22.8%. That’s well above the average rate of 12.32% for personal loans and 7.82% for five-year car loans.
The high-interest expense makes credit card debt harder to afford, which leads to other problems. Delinquency rates for credit card payments are higher than for other forms of consumer debt. According to the Federal Reserve Bank of New York, 7.1% of credit card payments became 90 days overdue in the third quarter of 2024.
This is a disturbing acceleration from the 4.96% delinquency rate a year earlier. It’s also much higher overall than the 1.68% rate for consumer debt.
What can debt consolidation do?
So, what is debt consolidation, and how can it help with this problem?
Debt consolidation involves borrowing money to pay off existing debts. One benefit is that it consolidates multiple monthly payments into one, making it easier to manage those payments.
Beyond simplifying payments, debt consolidation is most effective when it lowers the overall interest rate on your debt.
Opportunities to refinance debt
Given the sheer scale of credit card debt in the U.S., finding effective ways to manage and refinance it is crucial. Americans collectively owe over a trillion dollars in credit card debt, much of it carrying exceptionally high interest rates. Because of this, there are multiple options for refinancing, but understanding how debt consolidation and credit scores interact is key to choosing the right approach. These include:
- Personal loans
- Home equity loans
- Cash-out refinance mortgages
- Balance-transfer credit cards
A recent report by the Consumer Financial Protection Bureau (CFPB) on cash-out refinancing gives an example of how debt consolidation can help consumers.
The CFPB found that “pay off other bills or debts” was the most commonly cited reason people took out cash-out refinance loans. Their study found that people typically followed through on this goal. On average, cash-out refinance borrowers showed sharp declines in credit card and auto loan balances in the quarter when refinanced.
The CFPB also found that debt consolidation and credit scores are closely linked. After a cash-out refinance loan, credit scores typically rose sharply at first. While they declined somewhat over time, they generally remained above pre-refinancing levels.
Debt consolidation and credit scores: What could go wrong?
Borrowing to consolidate debt requires a reasonably good credit score, so it’s best to act before missed payments lower your credit. The relationship between debt consolidation and credit scores means waiting too long to consolidate could make it harder to qualify for better terms.
Also, a potential problem with paying off credit card balances is that it frees up those credit limits for further borrowing. If you continue the same spending habits, you could end up with more debt in the long run. Therefore, you shouldn’t take out a debt consolidation loan unless you have a plan for reducing your overall debt level.
This is especially important if you consider consolidating debts with a home equity or cash-out refinance loan. These loans put your home on the line, so you must have a solid plan for keeping up with the payments. If you fail to manage repayments, especially with a home equity loan, you could put your home at risk.
Keys to making debt consolidation work
Here are some keys to making debt consolidation work in your favor:
- Check your credit score to see if you would qualify for a debt consolidation loan or balance transfer credit card.
- Do whatever you can to improve your credit score before you borrow, to qualify for the best possible terms.
- Only consolidate debts when you get a lower interest rate on the new debt.
- Budget to make sure you can pay off the new debt.
- Change your spending habits so you don’t use debt consolidation as an opportunity to borrow more.
- After you pay off your credit card balances, sideline some of your credit cards, but don’t cancel the accounts. Having older credit accounts is good for your credit score.
The data on consumer debt shows that many Americans need help. Debt consolidation can be part of the solution but also carries risks. Before committing to it, it’s vital to understand how it works and plan to reduce your debt level over time rather than simply moving it from one place to another.
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Disclaimer: The article and information provided here are for informational purposes only and are not intended as a substitute for professional advice.
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