Consolidating Student Loans Can Improve Your FICO Score

Most people are aware that consolidating student loans can greatly lower their monthly payments. However, many borrowers don’t realize how great of an impact consolidating student loans can have on their FICO score. Consolidating student loans is perhaps one of the most effective ways to quickly improve your FICO score, in turn saving a great deal of money on future big ticket credit purchases like cars and homes.

The anatomy of a FICO score

A FICO score is derived from giving a numerical value to different elements of creditworthiness and running those numbers through a complex algorithm. The score considers your current and past financial situation in order to make a prediction about how likely you are to pay your bills on time in the future. Each credit-worthiness factor is weighted according to its importance:

35% - Payment history
30% - Amount of debt owed
10% - Length of credit history
10% - Types of current credit
15% - Miscellaneous

The direct impact of consolidating student loans on your credit

The first way that consolidating student loans positively impacts your FICO score is by closing all of the open student loans and replacing them with one, predictable, fixed interest loan. Because the amount of debt owed is such a highly ranked factor, reducing the amount owed can make a big impact on your overall score. Lenders most certainly consider debt to income ratio when deciding if you can comfortably take on a new payment. Because consolidating student loans can reduce your monthly student payment by up to 60%, your debt to income ratio can be significantly lowered.

If a graduate with a $30,000 debt pays around $313 per month before refinancing. After consolidating student loans, the new loan payment is around $106, freeing up an additional $207 per month. When considering the purchase of a new vehicle with a $300 monthly payment, having an extra $200 a month in disposable income can be a deciding factor on whether or not you can secure the auto loan at a favorable interest rate.

The indirect impact of consolidating student loans on FICO score

The reason most young adults find themselves in credit trouble is because they often need to rely on high interest credit cards to get through school and the years following graduation. People just out of college already have the chips stacked against them with a long future of student loan bills and plenty of things to purchase. Additionally recent graduates are usually just starting their careers and earning only a fraction of their likely future salary which makes it more difficult to pay off old credit card debt and easy to take advantage of new offers.

Saving several hundred dollars a month by consolidating student loans can give graduates the additional income needed to pay down harmful high interest credit card debts. If the student in the above example were to use the savings from consolidating student loans to pay down credit cards, this would add up to $2,400 per year and $12,000 over a span of 5 years.Being financially savvy is the art and practice of leveraging good debt to eliminate dangerous high interest debt.

Student loan consolidation: how it works to lower your monthly payments

When consolidating student loans, your lender pays off all of your existing variable interest rate loans then writes a new, fixed interest rate loan which you are then responsible for. The borrower still retains all of the benefits enjoyed before consolidating student loans such as the ability to defer payments or apply for forbearance.

The main reason why payments can be so much lower after consolidating student loans is that the loan can be spaced out over a longer period of time, thus reducing the amount due monthly. Borrowers can pay off the loan early at any time without penalty should they choose. By consolidating student loans, graduates can leverage what they have a lot of – time, against something that is generally less readily available – money.

Building a strong financial base and maintaining a healthy FICO score is a critical factor in the type of home you can own, the type of car you can buy, and the quality of life you can enjoy. Consolidating student loans today means taking the first step in building a strong financial future.

posted by Z3ede3 at 7:54 PM