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Student Loan Consolidation and Refinancing: Is it Good or Bad for my Credit Score?

Consolidating or refinancing student loans usually impacts borrower credit scores. However, the impact is typically small and short-lived.

Written By: Michael P. Lux, Esq.

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Temporary Forgiveness Clock Rule: The Department of Education is conducting a one-time update of IDR payment counts. Borrowers who consolidate their federal loans before June 30, 2024, can maximize progress toward PSLF and IDR forgiveness.

Many student loan borrowers can improve their credit score by consolidating or refinancing their student loans. Unfortunately, this is not a universal outcome as some borrowers might find their credit scores have dropped following a consolidation or refinance.

Despite the significant differences between federal direct consolidation and private student loan refinancing, their impact on a borrower’s credit score are usually similar.

In this discussion, we’ll explore the factors that can lead to an increase in credit scores and the situations in which a credit score might decline. We’ll also cover why credit score changes shouldn’t worry most borrowers or influence their decision-making too heavily.

How does loan consolidation improve my credit score?

When consolidating student loans, several aspects of a borrower’s credit profile changes. According to the credit bureaus, most of these changes improve a borrower’s creditworthiness.

One factor that determines credit score is the number of open lines of credit. Having too many can lower your score. Consolidation replaces multiple student loans with a single new loan. So, although you’ve maintained the same amount of debt, you have reduced your total number of credit lines. This can lead to a higher credit score.

Another way in which student loan refinancing benefits your credit score is that many loans will show up on your credit report as “paid in full”. Unsurprisingly, credit bureaus view a history of fully repaid debt as a positive. Depending upon how the loans are consolidated, your credit report could read that the loans were refinanced, or it could just say that they were paid in full. Either way, your credit score will likely receive a boost.

One final advantage of consolidating your student loans is that it can often lower your monthly payments. Lower monthly payments improve your debt-to-income ratio. This ratio is a key factor lenders consider when deciding whether to loan you money. If you’re looking to buy a home, improving your debt-to-income ratio can be crucial to achieving that goal.

Can Refinancing or Consolidation Cause a Credit Score to Drop?

While it would be ideal for consolidation or refinancing to lead to a predictable change in credit scores, the reality is that outcomes can vary widely.

In some circumstances, a borrower’s credit score can decrease.

The main explanation for a drop in credit score is due to the age of credit. A longer credit history tends to boost credit scores. However, consolidating or refinancing results in old loans being paid and marked as closed. This could negatively impact borrowers with a limited credit history outside of their student loans. Closing old student loan accounts in favor of a new consolidated or refinanced loan can significantly reduce the average age of your credit accounts, potentially lowering your credit score.

Although it is generally a minor factor, checking interest rates for consolidation or refinancing can cause a temporary dip in your credit score. Credit bureaus may view numerous credit inquiries as a signal that a borrower is experiencing a financial distress, making the borrower appear to be a higher credit risk. However, credit bureaus typically bundle inquiries from rate shopping within a short timeframe as a single inquiry, minimizing the impact. So, borrowers are still encouraged to check rates with many lenders in order to get the best deal.

Ultimately, most borrowers will likely see a small increase in their credit score following consolidation or refinancing. Yet, as some readers have experienced, there is also the possibility for a credit score drop.

Nevertheless, changes in credit score shouldn’t be a major concern when considering consolidation or refinancing, as the benefits of these actions often outweigh the temporary fluctuations in credit scores.

Most People Shouldn’t Worry About Their Credit Score when Refinancing

The desire to improve and protect a credit score is responsible, but it shouldn’t be the primary concern.

A high credit score’s real value lies in the ability to secure favorable lending terms. In other words, the value of a good credit score is the chance to save money.

The main goal of consolidating or refinancing student loans is precisely that – to save money. If your credit score is already sufficient to secure a low interest rate or advantageous repayment terms, then it has served its essential purpose.

Refinancing or consolidation has the potential to save you hundreds of dollars per month and thousands of dollars per year. With that much money at stake, worrying about what Equifax or TransUnion thinks might not be the best use of your time and energy.

However, an exception exists for those planning to buy a home soon. Even a fractional difference in mortgage interest rates can have a substantial financial impact over time. If you’re in this situation, it’s prudent to consult with a lender or mortgage broker before making any moves that could affect your credit score. These housing finance professionals can advise on the wisest course of action, helping you balance the benefits of loan refinancing or consolidation with the necessity of maintaining a good credit score for a home purchase.

The Bottom Line

Most borrowers should see a slight improvement in their credit score after refinancing or consolidating their student loans. However, it’s important to recognize that, for some, credit scores could temporarily decrease.

What’s crucial is the financial outcome of refinancing or consolidating. If these actions lead to cost savings, a temporary fluctuation in your credit score should be of minor concern. The primary goal is to enhance your financial situation; if achieving this goal results in a minor and temporary dip in your credit score, it’s generally worth the trade-off.

Have you consolidated your student loans? What tips or advice would you offer? Please leave your thoughts in the comments section.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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