How Does Consolidating Student Loans Affect Credit?

Americans have amassed over $1.4 Trillion in higher education debt. It’s no wonder there is a rising number of companies offering student loan consolidation help.

But what are the real benefits of consolidating your student debt? And how will it impact your credit? Let’s find out right now.

Many people think of their total student loan debt as one lump sum. However, unless you’ve consolidated your debt, that lump sum is probably made up of several loans with different interest rates and repayment periods. And they’re all categorized as installment loans. Mortgages and auto-loans also fall under this category.

Because installment loan balances fall over time, credit score algorithms — such as FICO — treat them differently than credit card debt and other types of revolving debt.

Why is this a good thing? Because it means that student loan debt will have less of an impact (if any) on your credit score than credit card debt. For example, $20,000 in student loan debt won’t hurt your credit score the way $20,000 in credit card debt will.

In fact, FICO reported that 7% of consumers with $50,000 or more in student debt had credit scores of at least 800.

The most important factor in how student loans will affect your credit score is your payment history.

“Overall, consolidating student loans has a very small impact on the borrower’s credit scores,” says Mark Kantrowitz, Publisher and VP of Strategy at Cappex.com. That is unless you’re unable to make your monthly payments. Once this starts happening, expect your credit score to plummet with each delinquency and bad mark.

You can turn that around, though. Consolidating your high-interest loans into a new loan could significantly reduce your interest rate.

A reduced interest rate can mean lower monthly payments. And a lower monthly payment will make it easier for you to pay on time, thereby raising your credit score consistently.

“If you’re unable to make your monthly payment, you should most definitely look into paying a lower amount through loan consolidation,” explains Chris Brantner, Founder of BillGeeks.com. He adds, “You can actually affect your credit score very positively if you consistently make your payments on time.”

Another benefit is that your debt-to-income ratio will also improve. This will make it easier for you to get a mortgage or car loan.

It’s also worth it to mention that, when you consolidate your student loans, your original loans are marked as paid off. As with any debt that’s paid in full, this will help boost your credit score.

There are some common scenarios where your credit score can take a hit, and when you consolidate your student loan debt, one or all of these could come into play:

Whenever you apply for a student loan consolidation, a lender has to make a “hard inquiry” on your credit. Hard inquiries are situations where you’ve applied for a line of credit. For example, things like a credit card, mortgage or auto loan are hard inquiries. If you have too many of these types of inquiries within a short period, it could temporarily lower your credit score. Borrowers with newer credit histories are also more likely to have a few points knocked off their score for just one hard inquiry.

If you consolidate your student loan debt into a shorter term loan than you had originally, you’ll save yourself from years of interest charges. But you’ll also increase the amount of your monthly payment. Lenders view consumers with a higher debt to income ratio as a risky investment, so your creditworthiness may drop.

Account age consists of 5 to 7 percent of your credit score. For young borrowers, student loans might be the first line of credit they ever applied to receive. If they become paid off through a student loan consolidation, that could drastically decrease the age of your oldest account, and therefore lower your credit.

All of these hits to your credit are temporary, and most experts agree that it’s more important to pay off your student loan debt than worry about small drops in your credit score.

As mentioned above, when you consolidate your student loans, your old loans are marked as paid in full. The balances are then combined into your new consolidated loan.

This new loan will remain on your credit report for as long as it is active and in repayment.

A consolidation loan follows the same rules as any other loan: all payment history will remain on your credit report for seven years. If you are late on a payment, you probably won’t be able to remove the negative mark until seven years after the missed payment date.

Everyone’s situation is unique, and there isn’t a one-size-fits-all solution for all of them. However, it’s safe to say that everyone has the same goal: to save money and get out of debt as fast as possible.

Student loan consolidation can be a tool to make achieving that goal easier.

By not consolidating, you avoid the temporary hit to your credit score, but you’ll still have all of those separate loans to pay off. And the more payments you have, the harder it is to pay them on time. All of those missed payments will eventually add up and negatively affect your credit score—the very thing you tried to avoid by not consolidating.

By consolidating your student debt, you’ll find it easier to make regular on-time payments (since you’ll only have one payment to remember). Those consistent on-time payments will have a positive impact on your credit score, which will more than compensate the points you may have lost when you first applied.

Saving money and getting out of debt is typically more important to people than worrying about the possibility of a temporarily reduced credit score.

The purpose of chasing a good credit score is to save money on interest when you borrow, but student loan consolidation can save hundreds of dollars each month on interest fees. Of course, you could also pay more in interest if you extend the term of your loan.

Student loan consolidation can damage your credit score in the short term, so you may want to avoid it when you are applying for a business loan or a mortgage.

So you’ve decided that you want to consolidate your student loans, but you’re not quite sure how to do it. Don’t worry. You’re not alone. There are many people who have considered the same question.

Whether you’re trying to lower your monthly payment, simplify the number of outstanding accounts, or get a better interest rate, there are dozens of lenders waiting to compete for your business.