loan sign illuminates the consequences of refinancing or consolidation on credit scores

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

Michael Lux Best Of, Blog, Consolidation, Lower Payments, Student Loans 82 Comments

Many student loan borrowers are able to improve their credit score by consolidating or refinancing their student loans.  Unfortunately, not all borrowers see an increase in their score.  Some borrowers may actually see their score drop by consolidating or refinancing.

Though federal direct consolidation and private student loan refinancing are very different processes, the impact to a borrower’s credit score is similar.

Today we will discuss the factors that can cause the credit score to increase, and the circumstances in which a credit score can drop.  We will also discuss the reasons that a credit score shift should not be a concern or consideration for most borrowers.

How does loan consolidation improve my credit score?

When consolidating student loans, a number of factors credit score variables are modified.  Most of these changes improve a borrower’s creditworthiness according to the credit bureaus.

One factor that determines credit score is the number of lines of credit that are open.  If consumers have too many, their score will go down.  By consolidating your student loans, many student loans are replaced with one new loan.  The borrower still has the same amount of debt, but the number of lines of credit goes down, thus raising the credit score.

Another credit score advantage of student loan refinancing is that many loans will show as paid in full.  It shouldn’t come as a surprise that a record of debt repaid is a good thing.  Depending upon how the loans are consolidated, it could read that the loans were refinanced or it could just say that they were paid in full.  Either way, the credit score goes up.

One final advantage of consolidating student loans is that it can often lower your monthly payments.  This helps borrowers who are looking for new lines of credit as it will improve their deb-to-income ratio.  This especially helpful for those trying to secure a mortgage.

Can Refinancing or Consolidation Cause a Credit Score to Drop?

It would be nice if consolidation or refinancing caused a predictable movement in score.  Unfortunately, it fluctuates greatly.

In some circumstances, a borrowers credit score can drop.

The main explanation for a drop in credit score is due to age of credit.  The longer a credit history, the better a credit score.  When consolidating or refinancing the old loans are paid in full.  This means that those lines of credit are marked as closed.  This could be bad for borrowers who don’t have any items on their credit report other than a student loan.  If the old lines of credit, the original student loans, are closed and the new loan is the only open account, the age of credit will drop significantly.

Another factor that has a minimal effect on credit score is checking interest rates.  Generally speaking, checking rates causes a short-term drop in credit score.  Too many credit inquiries can be viewed as a sign that a borrower is experiencing a financial hardship and is therefore more of a credit risk.  However, shopping around for the best interest rates is considered a single inquiry by the credit bureaus, 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, but as noted in the comments by some readers, it is still possible that the credit score can drop.

That all being said, the credit score movement shouldn’t be a concern…

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 first consideration.

The value in a high credit score comes from the ability to secure desirable terms in lending.  In other words, the value of a good credit score is the chance to save money.

The purpose of refinancing or consolidating student loans is to save money.  If the credit score is high enough to qualify for a low rate or favorable repayment plans, then the credit score has done its job.

In many cases refinancing or consolidation can save hundreds of dollars per month and thousands of dollars per year.  With that much money at stake, worrying about what Equifax or TransUnion thinks seems a bit silly.

The one exception would be for borrowers who are looking to purchase a home in the near future.  A fractional difference in interest rate on a mortgage can make a huge difference to the homeowner.  People on the hunt for a house should discuss any actions that might impact their credit score with their lender or mortgage broker.  The home loan experts should be able to recommend the best path forward.

The Bottom Line

Most borrowers should expect their credit score to improve slightly by refinancing or consolidating their student loans.  That being said, there are reasons that the credit score could drop for some people.

Ultimately, the thing that matters most whether or not refinancing or consolidating improves a borrower’s finances.  If the process saves money, a blip on the credit score radar shouldn’t matter.

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