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Debt Consolidation and Your Credit Score

Debt Consolidation and Your Credit Score

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Mark Cappel
UpdatedMar 6, 2014
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    5 min read
Key Takeaways:
  • Credit counseling has the lightest impact on your credit score.
  • Bankruptcy appears on your credit report for 10 years.
  • Debt settlement has a variable impact depending on your existing score.
  • Learn how credit reporting agencies calculate a credit score.

Learn How Credit Counseling, Debt Settlement, and Bankruptcy Affect Your Credit

Before we dive into the numbers, let’s clear up three confusing issues about credit scores:

  1. Independent credit reporting agencies publish consumer data. Equifax, Experian, and TransUnion are the three biggest. Other credit reporting agencies gather information about specific areas, such as home and apartment renting.
  2. Credit reports may contain different, incorrect, or even conflicting information. An account may appear in your Equifax report, for example, but not your Experian, or TransUnion reports. An account appearing (or not appearing) in one of your credit reports does not mean you owe a debt legally.
  3. You have many credit scores. The two most well-known credit score producers are Fair Isaac & Co., creator of FICO scores, and VantageScore, which publishes several versions of VantageScore. The two generate different numbers for the same consumer because the programs creating the scores were written by different companies.

FICO scores are used by virtually all mortgage lenders, credit card issuers, and vehicle finance companies. VantageScore is a new company, and is used more often by Web sites and others offering free credit scores. Use the free scores to get a ballpark idea of your FICO credit score. If you visit different Web sites to learn your credit score, you will receive different scores!

Debt Consolidation & Credit Score

Different debt consolidation strategies result in different impacts on your credit score. Let us start with the easiest one first — bankruptcy.


Under the Fair Credit Reporting Act, a bankruptcy can appear on a credit report for 10 years from the date of filing. However, because the FICO and VantageScore scores give more weight to recent items, the effects of a bankruptcy fade with each passing year.

According to Fair Isaac & Co., a person with a 680 starting FICO score will see their credit score drop to 530-550 following a bankruptcy. A person with a 780 starting score will see their FICO score drop to 540-560. VantageScore has not released similar information.

How long does it take to recover from a bankruptcy? Fair Isaac & Co. says that varies with how high a person wants their credit score to go. Presumably, this varies if the person files chapter 7 or chapter 13 bankruptcy, but Fair Isaac did not distinguish this in its data. We will assume a chapter 7.

For a consumer with a starting 680 score, the time to recovery to 680 is 5 years. For consumers with 720 or 780 starting score, the time to recovery is 7 to 10 years. Why the three-year range? That depends on the person’s other actions and history, including any delinquencies or positive actions the person takes. A consumer with an array of active, strong accounts will recover faster than a person with few active accounts.

Debt Settlement

Debt settlement is a process where the debtor stops paying their accounts, and instead deposit funds monthly into a special bank account. As the account balance builds, the debt settlement provider negotiates lump-sum settlements to resolve the debt. The results of debt settlement are three:

  • The debtor resolves the debt quickly — usually 2 to 4 years
  • Debts are resolved for less than the full balance
  • Enrolled debt is reported to the credit reporting agencies as delinquent until settled, and then it is reported as "Settled for less than full balance."

Creditors report late and non-payments to the credit reporting agencies. For a person with a starting score of 680, they will see a 30-day late on a credit card drop their score to 600-620. A settlement will result in a score of 615-635. For a person with a 780 score, a 30-day late will from drop their score to 670-690. A credit card settlement will result in a score of 655-675.

Consumer Credit Counseling Service

Credit counseling is the most difficult impact to calculate. According to Fair Isaac & Co., "Whether or not you are participating in a credit counseling of any kind," is not included in a FICO score. However, enrollment is noted on a credit report. If you seek a loan while enrolled, prospective lenders will see you are in a debt management program, and may use that as an excuse to deny your loan or charge you a high interest rate. Also, some credit card issuers will close an account enrolled in a credit counseling debt management plan, which may decrease your credit utilization. Higher available credit tends to push up your credit score, and less available credit harms your score.

The first month in a credit counseling debt management plan can get messy because not all bills are due on the same date. It is easy for one or more accounts to get dinged with a 30-day late at the start of a credit counseling debt management plan. Therefore, it may be precise for Fair Isaac & Co. to say credit counseling in and of itself causes no credit score harm, but the secondary effects of a debt management plan harm your credit score.

At the end of a credit counseling plan, which customarily take 5 years, a consumer may see a higher, same, or lower score based on their other activities. A person with financial discipline will see their scores increase because of 5 years of positive history. But a score may decrease because of less credit utilization. However, if you increase balances on other accounts or are late on mortgage or vehicle payments, the positives of paying off enrolled accounts will be offset by your negative activities.

Consolidation Loan

Fair Isaac & Co. has not published specific information about the impact of a consolidation loan on consumers’ credit scores. We can make an educated guess, however. If your consolidation loan is a cash-out refinance, then the net impact on your credit score will be positive because you increase your amount of available credit. However, if your consolidation loan is a personal loan, then your available credit is increased, but not as dramatically as a cash-out refinance.

If the consolidation loan allows you to make all of your monthly payments on time, then your credit score will gradually increase.

Bills Action Plan

Answering the question, "How does debt consolidation affect my credit?" depends on which debt consolidation strategy you use. Pick credit counseling if it is imperative for you to keep a high credit score. If you do not plan to apply for any new lines of credit in the next few years, then the effects of bankruptcy and debt settlement can be reversed by focusing your energy on paying your other accounts on time.