Does Auto Loan Debt Consolidation Hurt Your Credit?

If you have multiple debt and loan payments to make every month, you know that it can be overwhelming and stressful to stay on top of them and make your payments on time. The stress can be magnified if you’re paying a high interest rate on an auto loan, as you might if you took out a dealership loan or had a lower-than-average credit score when you bought your car.

At Addition Financial, we often offer advice to our members to help them build or rebuild their credit, and that includes discussing debt relief and consolidation. One question we hear frequently is this.

Does debt consolidation hurt your credit?

Since your credit score can impact everything from your ability to buy a home to your employment, that’s an important question to ask before you choose auto loan debt consolidation. Here’s what you need to know.

How Does Auto Loan Consolidation Affect Your Credit?

There are several ways in which debt consolidation can impact your credit score. These include both positive and negative ramifications.

Hard Credit Inquiry

Any type of debt consolidation you choose will involve a hard credit inquiry that your creditor will use to evaluate your ability to repay a debt consolidation loan or credit card balance. The most common methods for auto loan consolidation are personal loans, home equity loans and home equity lines of credit. Some people consolidate their car loan on a low interest rate credit card, but there are some significant downsides to doing so.

Your lender (or a credit card company) will pull your credit report when you apply for a debt consolidation loan or balance transfer card. The result will be a dip of five to ten points in your score. The good news is that you’ll only get dinged for a single inquiry even if you apply with several lenders, provided all inquiries are made within the 14-day grace period.

Credit Mix

Potential creditors prefer to see a mix of credit when they pull your credit report, including the following:

Revolving credit, which includes credit cards and lines of credit
Installment credit, which includes loans such as auto loans and mortgages

If you consolidate your auto loan with a personal loan or a home equity loan, it won’t impact your credit mix because you’d be switching from one installment loan to another.

The exception would be if you decided to consolidate your car loans on a low interest rate credit card or a home equity line of credit or HELOC. In that case, you’d be moving your debt from an installment plan to revolving credit. If you don’t have another installment credit in your credit history, it’s possible that your credit score will drop as a result of consolidation.

Credit Utilization Ratio

Your credit utilization ratio is calculated by totaling the credit you are using and dividing it by the total credit available to you. Auto loan debt consolidation can impact your credit utilization in several ways:

Your old loan amount will be paid off, which under normal circumstances would cause a drop in your credit utilization and an increase in your credit score.
However, your new loan will be added to your available credit and your outstanding credit.
If you use a balance transfer credit card, your balance transfer fees will be added to your balance and increase your credit utilization, causing a decrease in your credit score.
If you used a credit card to pay part or all of the closing fees associated with a loan, or if you financed your closing fees, those will also add to your credit utilization.

Keep in mind that if you do experience a drop in your credit score due to balance transfer fees or closing fees, it’s in your best interest to pay down that existing debt as quickly as possible to increase your score.

New Credit Account

Whether you take out a new loan or get a balance transfer credit card to consolidate your auto loans, opening a new credit account will cause a temporary dip in your credit score. That’s because creditors view new accounts as being higher risk than long-standing accounts.

Average Age of Accounts

When you pay off a loan with consolidation, the old account is closed. You won’t have the option to leave the account open, as you would with a credit card.

Opening a new account means that you’ll be closing an older account and adding a new one, both of which will decrease the average age of your accounts. The impact on your credit score should be minor and it should steadily improve as you make payments.

Payment History

There are several elements that go into calculating your FICO score and your payment history is the most important, accounting for 35% of your score. FICO has said that open accounts have a greater impact on scores than closed accounts, so paying off a loan before its term is finished could cause a small dip in your credit score.

We should note that making on-time payments is one of the most reliable ways to increase your credit score, so if you’re working to build or rebuild your credit, you may want to hold off on debt consolidation provided that high monthly payments aren’t impacting your ability to pay on time.

Lower Monthly Payments/Total Debt

While consolidating auto loans may cause your credit score to get lower at first, there’s no need for alarm. Most people will experience only a small decrease and can get back on track quickly.

The easiest way to get your credit score up again is to make on-time payments on your new loan or credit card and on all other outstanding balances. You can also improve your credit by sticking to a budget and not engaging in excessive spending that will increase your credit utilization and debt to income ratio.

How Long Does Debt Consolidation Stay on Your Credit Report?

Another question that we hear frequently is how long debt consolidation will stay on your credit report. There are two things you should know:

Negative credit experiences, including delinquent payments, will stay on your credit report for seven years.
Closed accounts that are paid as agreed may stay on your credit report for as long as 10 years.

A closed account that you paid due to debt consolidation will stay on your credit report but should not be viewed as negative by any potential creditor. While you may see a temporary dip in your score after debt consolidation, the bottom line is that consolidating your auto loans can help your credit in the long run, particularly if you’re able to qualify for a low interest rate that reduces your monthly payment.

It’s always a good idea to review your credit report regularly to make sure that the information on it is accurate. If you find an error, you can request a correction and that may have a positive impact on your credit score.

Is Auto Loan Debt Consolidation Right for You?

There are many reasons to consider your auto loan debt consolidation options. If any of these statements apply to you, then it’s possible that consolidating your car loans could be beneficial:

You’re juggling multiple car loan payments. Many families these days have two or more vehicles, particularly if they have teenager or young adult drivers. If you have multiple loans and find it to be a hassle to make multiple debt payments each month, then car loan consolidation may be helpful because you’ll only need to make one payment per month.
You have one or more car loans with high interest rates. It’s common for people to take out dealership loans that have high interest rates and less favorable loan terms than credit union or bank loans. Debt consolidation may make it possible to get a loan with significantly better rates that will save you money on your monthly payments as well as in the long term.
You’re struggling to make your monthly payments. If your credit score has improved significantly since you bought your car, you might be paying more per month than is necessary. The same may be true if you have one loan at a good interest rate and one at a high interest rate; your total combined payment may be significantly reduced if you consolidate your loans.
You have financial goals and stick to a budget. Debt consolidation can be particularly useful if you have short-term and long-term financial goals and want to pay down your debt quickly. Consolidating auto loans can help you reduce your debt to income ratio and improve your credit score.

As we mentioned above, we might suggest waiting to consolidate your auto loans if you’re in the process of building or rebuilding your credit. You might not be able to qualify for the best interest rate if your credit score is lower than average, so your best option is to continue making on-time monthly payments until your score will allow you to consolidate and save money.

Consolidating auto loan debt may be a good option for debt management, but it’s important to be aware of the short-term impact it will have on your credit. A small dip in your credit caused by debt consolidation may not matter much unless you have immediate plans to buy a home or you’re seeking employment where your credit score will be a factor.

Are you considering auto loan debt consolidation or working on a debt management plan? Addition Financial Credit Union has affordable debt consolidation options to help! Click here to read about our personal loans and begin the application process today.