What Kind of Debt Consolidation Won't Hurt My Credit?

Debt consolidation options are often looked at by borrowers to reduce their debt load and maybe help their credit score, but they can have the opposite effect. Whether a debt consolidation plan helps or hurts your credit depends on how you go about it. Usually, however, debt consolidation is a band-aid for more serious financial mismanagement.

Types

Debt consolidation is a term used for several types of debt management. Traditional debt consolidation packages several loans into one larger loan, which hopefully lowers a person's monthly payment or at least only requires paying a single creditor. Debt management plans are also sometimes called debt consolidation. In a DMP, a credit counselor negotiates a more affordable payment plan for the debtor or advises him to stop paying to force the creditor to settle on the balance -- both of which have the potential to hurt a score. Settling a debt, even if you just negotiate lower payments, can lower a score by up to 125 points.

Effect of Debt Management Plan

Opting for a debt management plan has the potential to destroy your credit, because the single payment to the counselor may not meet the monthly minimum for all creditors involved. This results in the creditor reporting the account as delinquent. If you can meet the minimums, your score improves. Also, some lenders look upon credit counseling as just as bad as bankruptcy. If you settle the debt, you could pay less than half of what you owe, but also hurt your credit score, because the account will say settled rather than paid in full.

Considerations

All debt consolidation plans have the potential to harm your credit, because it might entice you to keep overspending. A debt consolidation loan, for example, usually adds to the cost of your debt financing, because it takes longer to pay off. Zero percent interest teaser rate credit cards may offer a reprieve from finance charges, but give you additional credit that could entice you to spend more. Also, acquiring a credit card or new loan might require a credit check, which dings your score by three to five points.

Tip

You may be able manage your current debt without getting a new loan. Credit card companies, for instance, may lower your interest rate if it looks like you won't be able you meet your payments. Also, try to make the largest payment possible on the loan with the highest interest rate, while meeting the minimum on your other accounts, suggests MSN Money Central.