Loan consolidation can be a great solution for accumulating debts. But while it can save you time and money, will loan consolidation hurt your credit?

Read on to find out how entering into a loan consolidation arrangement may impact your credit.

What is loan consolidation?

Loan consolidation combines several outstanding debts into one, with the goal of paying a lower interest rate, a smaller monthly repayment amount, or both. There are a few loan consolidation options, including a balance transfer credit card, unsecured personal loan or mortgage refinancing.

What is my credit score, and why is it important?

Your credit score is a snapshot of your financial life. Calculated by one of Australia’s credit reporting bureaus, your credit score is a reflection of your current credit information, balances, payment defaults, bankruptcies and financial inquiries. The higher your credit score, the better.

Any time you apply for credit, the lender will contact the credit reporting bureaus for your credit score. They use your score as one of their deciding factors when deciding whether to approve or decline your application.

If you have a good credit score, not only are you more likely to be approved for a loan or credit card, but you will be in a better position to negotiate a lower interest rate.

How loan consolidation can improve your credit score

Entering into a loan consolidation arrangement can help improve your credit score under the following circumstances:

• You make your consolidation loan repayment on time every month. This is the biggest contributing factor towards your credit score.
• If you currently have credit card balances that are higher than 30% of the credit limit, paying the balance through debt consolidation will lower your credit utilisation, which will help your score.
• You address the problems that lead to your original debts becoming unmanageable. Creating an accurate budget, examining and lowering your expenses and seeking financial advice all complement loan consolidation.

How loan consolidation can hurt your credit score

Loan consolidation may see your credit score dip if:

• You don’t make the repayments on time. Allowing defaults to occur will have a big negative effect on your credit score.
• You restart the debt cycle by using the credit cards that you repaid through a debt consolidation loan. Remove the temptation by not carrying your credit cards and avoiding online shopping. It’s best to not close the accounts straight away (as this will affect your credit utilisation) but it is better to close them than to fall into more debt.
• You submit multiple loan consolidation applications. This is because each time you apply for credit, your credit score will be lessen slightly. Numerous credit applications across a short timespan can also lower your score as it can be interpreted as a sign of financial instability.

So loan consolidation can both help or hurt your credit, depending on how you go about it and how well you look after your finances over time.

But with good discipline, loan consolidation can help improve your credit score while you lower your debts.