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Consolidating student loans affect credit score
One of the most common pieces of advice I hear about student loans and credit scores is "be careful about paying off your loans too early because it might lower your credit score." This always sounded a little odd.
When I was considering whether to repay my student loans more quickly than required, I wondered at this advice and really wanted to understand why that might be the case.
So I did a little research -- including a wild Saturday night poking around on the FICO Banking Analytics blog -- asked some of my very intelligent colleagues about it, and started monitoring my credit.
Why share all this confusing nonsense about credit scores and bureaus?I refer you back to my wild Saturday night where I stumbled across something from the FICO Banking Analytics blog.The people who calculate the most widely used credit score write "I'd like to set the record straight on exactly how student loan debt is factored into the FICO® Score." "A student loan receives no special treatment by the FICO® Score; it is treated like any other installment loan." Oh...so it's basically just like financing a fridge with equal monthly payments? FICO: "Yeah, a fridge." (Now I'm paraphrasing.) So, if that's the case, how and why would paying off an installment loan early adversely affect your credit?The answer is this: what considered by FICO, and many other credit scores, is the diversity of your credit.Generally, your score is improved by having multiple types of credit, such as credit cards and different kinds of loans.So if the installment loan you have is a student loan (which is the case for many student loan borrowers) and you fully pay off your student loan, then you have reduced credit diversity by eliminating that type of credit.This, as far as I can tell, is the only way in which paying off a student loan early adversely affects your credit.And so, if people are right in saying that paying off early can reduce your credit score, why do I say that shouldn't really matter?The most important factors used to determine your credit score include a good payment history, how much you currently owe, the length of your credit history, and a lack of derogatory marks such as defaults or bankruptcy.Furthermore, according to FICO, the factor of "types of credit used" only accounts for roughly 10 percent of the score, whereas "amounts owed" corresponds to roughly 30 percent.