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The Consequences of Student Loan Refinancing and Consolidation on Credit Reports

Consolidation and refinancing can have temporary and long-lasting impacts on your credit report.

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.

Student loan consolidation and refinancing are excellent tools for borrowers hoping to get their finances in order.

Refinancing enables borrowers to get lower interest rates and/or lower monthly student loan payments. Federal consolidation can help borrowers qualify for favorable repayment plans and forgiveness programs.

In both a refinance and a consolidation, old loans are eliminated and replaced with new loans.

Unsurprisingly, this debt modification can have an impact on credit scores and credit reports.

A Possible Credit Reporting Timeline Glitch

During the process of a refinance or consolidation, some strange things can happen on the borrower’s credit report.

In some cases, both the old loans and the new loan(s) may appear on the credit report. For a time, it may look as though the borrower has double the debt. This can temporarily tank the borrower’s debt-to-income ratio.

The good news is that this issue is often short-lived. It happens because the lender responsible for the new loans may quickly report the new debt while the old lenders are slow to report that the old loans are paid off.

For this reason, borrowers who are looking to buy a house should plan ahead. Those that want to refinance or consolidate should try to complete the process with several months to spare. This will give the creditors and reporting agencies sufficient time to get things in order.

Credit Score Uncertainty

Projecting credit score changes is an inexact science. The major credit agencies keep the inner workings of their algorithms a secret, and there are many different types of credit scores, so it can be very difficult to compare apples to apples.

What we do know for certain is that eliminating some loans and creating a new loan will have an impact on your credit score. In the short-term, it is possible that the score may drop, but most borrowers should find that their score actually improves in the long run.

There are a couple of reasons that a score might increase as a result of consolidation or refinance:

  • Old loans will show up as paid in full.
  • Using one loan to pay off several old loans means fewer lines of credit.

Unfortunately, there are also a couple of reasons that a score might drop:

  • The oldest line of credit may be closed when the student loan is paid off.
  • A hard inquiry (credit pull) can cause a drop in credit score.

Those concerned about how their credit score may be impacted should check out our more detailed analysis of the credit score consequences.

Debt-to-Income Ratio: Potential for a Major Credit Report Change

Many people fixate on the credit score changes, but the Debt-to-Income (DTI) ratio changes are perhaps the most significant.

A common misconception is that DTI refers to a consumer’s total debt compared to their total income. In reality, DTI looks at a consumer’s monthly bills compared to their monthly income.

When student loans are refinanced, the monthly payment usually changes. In some cases, borrowers will opt for a five-year repayment plan in order to secure the lowest possible interest rate. The downside to this option is that their minimum monthly payment will actually go up, which hurts their DTI. Having a higher debt-to-income ratio will make it harder to qualify for credit in the future as it will appear to lenders that you are on a tighter budget.

However, borrowers who opt for a longer repayment term, such as 20 years, may find that their DTI is improved considerably. The downside is that the long loans don’t’ have interest rates as low as the 5-year loans. The benefit is that it can make qualifying for a mortgage or car loan easier.

At present, the five-year loans start at around 2%, while the 20-year loans start at over 4%.

Final Thought: Keep an Eye on the Big Picture

Consolidation and refinancing are excellent tools for helping get student debt under control.

Borrowers are wise to consider how these moves might impact their credit report and credit score. However, it is important to keep priorities in order.

If a borrower concludes that their credit score may drop due to consolidation, it doesn’t mean that the borrower shouldn’t consolidate. A slight reduction in credit score is a small cost compared to the potential savings that can be realized.

On the other side of the equation, some people may need to improve their credit score for employment or purchasing a house. If a small drop in credit score could potentially have devastating consequences, it might be best to temporarily hold off on refinancing or consolidation.

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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