By John Campbell

Consolidating your debts can be an excellent way to save money and lower your monthly interest payments. What lenders offering debt consolidation loans or credit card balance transfers neglect to mention is that consolidating your debts will often lower your credit score in the short term.

You may be asking yourself, “How could consolidating my debts possibly lower my credit score?” The answer lies in the mysterious formula the three national credit bureaus use to compute consumer credit scores.

Your credit score is determined, in part, by the following:

• The number of credit accounts you’ve opened
• How long you’ve had your credit accounts
• Your total available credit
• How close your credit accounts are to their limits

What makes the credit scoring formula so mysterious is that nobody can adequately explain exactly how little or how much debt will lower your credit score. All that is known is that you should use no more than 30 percent of your available credit on any credit card you may have. Everything else is a mystery.

The best credit scores seem to be generated by consumers who have a number of credit accounts more than five years old and continue to use their credit while making their required minimum payments on a regular basis. Your credit score won’t go up if you never use your credit but will go down if you use too much credit. Finding a happy medium can be a tricky task.

When you transfer a number of debts from your credit accounts onto a new account, your credit score could be lowered in the short term. This often happens because having outstanding balances on many of your credit accounts is considered a positive factor when your credit score is calculated. Let’s say, for example, that you have around $5,000 in debts spread among four or five different credit cards with fairly high credit limits. You open a new credit card account with a $6,000 limit to take advantage of a 0 percent balance transfer offer. Once you’ve transferred the balance your credit report will indicate that you’re close to maxing out one of your accounts. This could look bad, regardless of your other accounts, and cause your score to be lowered.

Chances are you’re not going to end up losing a significant amount of points by doing one balance transfer, but depending on what your current credit score is you may not want to lose any points. If you’re on the borderline between a fair, good or excellent credit score, every spare point can make a world of difference. It could prove the difference between a more expensive mortgage or other loan if you need to make a large purchase soon after consolidating your debt.

As a general rule of thumb, you should only consolidate your debts when you don’t plan to open any additional lines of credit or take out a loan for at least six months. For example, if you’re less than six months away from applying for a mortgage and your credit score is hovering just above 750, any dip below that ideal score could disqualify you from a mortgage with the best rates available. The money you save on your various credit card interest payments could pale to the extra interest you could end up spending on a mortgage just because your credit score went down a few points.

Over time, paying off a consolidated debt will likely help increase your credit score. As long as you aren’t planning to immediately open new lines of credit or your credit score isn’t on the verge of falling into a less than ideal category, any potential short-term lowering of your score shouldn’t have a negative impact on the interest rates you may end up paying on future lines of credit.

Knowing your credit score and carefully weighing the pros and potential cons of debt consolidation will help you decide if it’s right for you.

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John Campbell is the writer and editor of CashBuzz, A financial portal for the rest of us. Check out cashbuzz.com for the latest articles on money management and tips and tricks that can help improve your finances. This article may be reprinted on your Web site if the copyright, author information and active link are included.