With total U.S. student loan debt surpassing the 1.4 trillion mark, borrowers have become even more reliant on debt to finance their education. And with plans from public and private lenders, loans are usually spread across multiple institutions.
Student loan consolidation allows you to turn multiple small loans into one large loan financed by a single lender. When applied, the new lender pays off all of your student loan debt and refinances the debt into a single loan.
Previously, we outlined how student loan refinancing can help you obtain a lower interest rate.
But can consolidation actually increase your credit score as well?
Public student loans are offered through the U.S. Department of Education. Its Federal Student Loan Portfolio is comprised of billions of dollars from Federal Direct Loans, Family Federal Education Loans (FFEL), and Perkins Loans. For more information on how public student loans work, check out our Federal Student Loan Interest Rates article.
When a payment is made each month, your funds are directed to a federal student loan servicer. The debt collector is assigned by the U.S. Department of Education and is used to make collections on its behalf. Because many student loan borrowers make one large payment per month, they’re often surprised to find out the entire sum is actually spread across multiple lenders. For example, if you take out a student loan at the beginning of each academic year, you can have as many as four separate lenders listed in your credit report.
When you consolidate several active loans into a single credit account, it reduces the noise in your credit report, making you look more reliable in the eyes of lenders. More importantly, credit scoring models – like FICO, Experian, or TransUnion – consider your active credit accounts when quantifying your credit score.
So while consolidating your student loans won’t actually remove the accounts from your credit report – instead, they’ll be labeled as ‘paid’ – the process does shrink the number of active accounts, which reduces your overall credit risk. Now, before you get too excited, the bump in your credit score will only be marginal. Other variables like your payment history, credit utilization, and debt-to-income ratio, hold much more weight in most scoring models. However, every point counts. Student loan consolidation is a way to move your credit score positively.
If you miss a payment, you end up defaulting on multiple small loans issued by multiple lenders in the previous scenario. In your credit report, each account will be labeled as past due. This is extremely damaging to your credit score because scoring models will result in several delinquencies instead of just one.
Now imagine you’ve consolidated your student loan debt.
If you miss a payment, the ‘past due’ label will still apply. However, now, the delinquency only affects a single account. Your credit score will take less of a hit because the late payment is confined to one account.
Before deciding whether student loan consolidation is right for you, remember that consolidation requires you to convert your public student loan into a private student loan. Because of this, you need to consider multiple factors before making your final decision.
While student loan consolidation can provide a slight increase in your credit score, you need to weigh multiple factors before making the switch. The tactic’s benefit is shrinking a large number of small loans into a single debt account. By doing so, you decrease the active number of credit accounts in your credit report, which helps lower your risk in lenders’ eyes. After consolidation, a missed payment’s negative effect also decreases in magnitude. On the flip side, switching from a public to a private student loan requires you to forfeit many of the benefits embedded in public student loans. These include financial assistance, delayed repayment, and loan forgiveness. Thus, before you make your final decision, we recommend weighing the pros and cons and choosing the option that works best for you.