Student Loan Consolidation, Credit Age and Credit Score

Michael Lux Blog, Consolidation, Mailbag, Student Loans 0 Comments

In this edition of the Sherpa Mailbag we take a look at the credit score questions of Jane.  She is trying to improve her credit and is worried that her student loans may be dragging it down.  If you have a question for the Sherpa, feel free to ask us!

Jane writes:

I have 10 student loans currently.  Every time I get a student loan it marks as though they are two (1 subsidized, 1 unsubsidized).  It is DRASTICALLY hurting my credit age by lowering it. My credit age based upon an average of my student loans ONLY is 2.2 years old.  

I also have 5 open credit cards and the average age based upon my credit cards ONLY is 7.6 years old.

All payments are timely and I have zero derogatory remarks on my credit.  The two things killing me currently are: (1) my credit card balances are at approx 60% (which I will not be able to reduce substantially in the near future due to interest rates and my inability to secure a personal loan with much more favorable terms) and (2) my credit age (drastically lowered as a result of  my student loan age).

I have a VERY important question.  If I were to consolidate all of my student loans into one loan with a fixed rate (which I understand may change subsidized/unsubsidized nature or have other effects), would that remove all of the 10 student loan accounts insofar as credit age.  In other words, would my credit age be simply reflected as the credit card age 7.6 plus the reduction resulting from the one new loan, assumed at one month, still retaining in the 7+ year range?

This could substantially aid me in improving my credit score and getting a loan with reasonable interest rates that could help me lower my credit card debt.

I have searched and searched for an answer to this question but have been unable to find one.  Any assistance you can offer would be greatly appreciated!

The Consolidation Question

Before we dig too deep into Jane’s question, it is important to clarify an issue.  Jane is references federal student loan consolidation.  Federal direct consolidation is a service performed exclusively by the Department of Education.  Most borrowers pursue federal consolidation for purposes of converting certain loans, such as FFELP loans or Perkins loans, into federal direct loans in order to qualify for certain repayment and forgiveness programs.

Federal consolidation is open to all borrowers, regardless of credit score or income.  Once the loans are combined, the interest rate is based upon the weighted average of the existing loans, so the impact on interest rates is minimal.  This is a significantly different process than refinancing student loans with a private lender.  Federal consolidation combines federal loans while private refinancing is done in order to lower interest rates.

Jane seems to be considering federal consolidation for the sole purpose of increasing her credit score.

Understanding Student Loans and Your Credit Score

Jane has clearly done a great deal of research into the factors effecting her credit score.

Unfortunately, credit score is not something that can be easily calculated.  FICO, the most common credit score, is actually calculated differently by different companies.  A move that might help your FICO score with one lender could hurt it with another.

The myFico blog has a nice breakdown of the five basic components of your credit score.  As Jane noted in her email, her credit utilization is an issue, and it comprises 30% of her credit score.

Consolidating her federal accounts would help her credit score in a couple ways.

First, it would reduce the number of open accounts, which is a factor according to Experian, one of the major credit bureaus.  Second, it would show that the old loans have been paid off in full, which should also improve her score.

Unfortunately, there is a downside to consolidation.  Closing accounts can reduce the age of your oldest account.  According to TransUnion, another one of the three major credit bureaus, closing the wrong account can hurt your credit score.  Paying off a loan in full is the same as closing the account.

If we had to guess, Jane might see a drop in her score initially from this move, but in the long run, it is likely a net positive to the credit score.  Sadly, this is an educated guess and nothing more.  There are too many variables at play to reach a conclusion with any level of certainty.

Consolidating to Improve your Credit Score

Setting aside the guesswork involved in projecting the credit score impact, consolidation is a financial move that should be considered from an entirely different perspective.

For some federal student loan borrowers it is an essential move as it helps their loans gain eligibility for certain programs.

For others it could be a mistake, starting certain forgiveness clocks back at zero and eliminating the ability to pay off smaller loans in their entirety.

We won’t dig deep into this particular subject to answer Jane’s question, but it is worth noting that the consolidation question requires some research and thought.  In other words, it probably isn’t a shortcut to improve your credit score.

Jane’s Strategy

Jane may attempt to use federal consolidation to help her credit score, but it likely will not improve things in the manner she hopes.

The biggest factor she is facing is total credit utilization.  Once she is able to gradually work down her credit card balances, things will definitely improve.  It is an uphill battle when fighting high credit card interest rates, but success can snowball.  As one card gets paid off, more money is freed up each month to attack the other cards.