Student Loan Consolidation and Refinance: How It Affects Your Credit

Student loan consolidation (or refinancing) can help streamline repayment if you’re juggling multiple monthly payments or loan servicers. As with any financial decision, you’ll need to weigh the pros and cons of consolidation, including whether it will impact your credit score.

But before we move forward, we first need to tend to some general housekeeping terms that can often trip up student loan borrowers. Although they’re used interchangeably, consolidation and refinancing are two different processes.

Technically, consolidation refers to the Federal Direct Consolidation Loan, which combines your existing federal student loans into one new loan. Whereas refinancing takes place with a private student loan lender. However, they function similarly in that they replace multiple student loans with one easy-to-manage loan.

Now, let’s focus our attention on an important borrower concern: Will consolidating my student loans help my credit or hurt it?

Student loan consolidation and refinancing have many benefits, including the potential to give your credit score a boost. But that doesn’t mean you should automatically run and consolidate your student debt.

Here are the main issues to remember when considering student loan consolidation and your credit score.

How does student loan consolidation affect credit?

The process of consolidating your student loans won’t have a significant impact on your student loans. But it could save you from wreaking havoc on your credit if you’re unable to make your monthly payments.

Once you start missing payments, each of your student loans will reflect a delinquent payment until you eventually find yourself in default. And your credit score will drop with each negative mark.

Loan consolidation is an effective tool for making your monthly payments more affordable, which can make you less likely to miss a payment. This can build a positive payment history that will improve your credit over time.

Here are some additional benefits that can improve your credit when it comes to student loan consolidation.

• You can reduce your interest rate. The lower your interest rate, the less you’ll pay in interest over the life of the loan. It can also reduce your monthly payment and allow you to throw extra payments at your student debt, which can have a positive impact on your credit as you pay down your loan.
• You will consolidate multiple loans into one. Even if the total amount of your student debt remains the same, it’ll look better on your credit to only have one open account.
• You can improve your debt-to-income (DTI) ratio. This ratio compares how much you owe each month to how much you earn. And it's used by various lenders (e.g. mortgage and auto) to determine if you’ll be able to afford a loan payment. So, when you lower your monthly student loan payment, you’ll also reduce your DTI which can improve your creditworthiness.

Each of these refinancing perks can indirectly boost your credit. But your biggest credit bump will come from maintaining a positive payment history.

Will refinancing student loans hurt my credit?

There are a few instances where refinancing could negatively impact your credit. But these potential dings to your credit are usually temporary and can be planned for.

The most common scenario is a result of the refinancing process with a private lender which requires a hard credit check.

When you apply for a line of credit, the refinancing lender performs a hard inquiry on your credit to determine your creditworthiness. And these types of inquiries stay on your credit report for over two years.

Fortunately, many student loan refinancing lenders only require a soft credit pull when you’re in the initial lender comparison phase. This allows the lender to provide you with a preapproval offer without an actual credit application.

But this feature isn’t offered by all lenders. And each lender will eventually need to perform a hard credit pull in order to make a final lending decision.

The impact of hard credit checks

A single hard inquiry won’t hurt your credit. But you could see a temporary dip in your credit score if you have multiple hard inquiries within a short time period.

To avoid this negative credit impact, limit your comparison shopping to as short a timeframe as possible. Credit bureaus will then assume you were comparing offers to get the best deal instead of looking to open numerous accounts all at once.

Note that this scenario won’t impact borrowers who choose to move forward with a Federal Direct Consolidation Loan because this option doesn’t require a credit check for approval.

Other consolidating scenarios that could hurt your credit

Depending on your situation, you might run into some other common scenarios that could result in a temporary credit dip.

For example, if you consolidate your student loans into a shorter-term loan to save on interest, your monthly payment will increase. And a higher monthly payment translates to a higher DTI ratio, which could affect future lending decisions.

You might also see a drop in your credit score if your student loans are considered some of your oldest credit accounts. A small portion of your credit score is determined by the length of your credit history, So, paying off your older student loans (in exchange for a new consolidated loan) could affect your average account age and, therefore, lower your credit.

Should you consolidate or refinance your student loans?

Borrowers consolidate their student loans for many reasons. But if you’re struggling to make your monthly payment, a more affordable payment through refinancing could prevent you from damaging your credit.

For example, let’s say Kevin has $80,000 in private student loans at 7% with a 10-year loan term. His current monthly payment is $929, but he’s at risk of missing payments because of his financial situation.

Kevin could refinance into a 20-year loan at 4% and significantly lower his monthly payment to only $485. By extending his payment over 20 years, he’d be tacking on about $5,000 in interest charges over the life of his loan.

But by consolidating his loans with a lower interest rate on top of the extended repayment, he would also lower his risk for missing payments and, therefore, protect his credit.

Use our refinance savings calculator to plug in your own numbers and see if you could benefit from consolidating your student loans.

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