A common question asked by people looking for student debt help is “Should I pay off my credit cards or my student loans first?"
This is a tricky question, and the answer depends upon a number of factors, including;
- The rate of APR on your credit card and your student debt
- The repayment terms
So lets look at a typical student debt help example. Let's say your credit card debt costs you 7.9% APR, while your student loan costs perhaps 3% APR.
In that situation it makes sense to pay the minimum towards your student loan and put the rest of your money towards repaying your credit card debt. As long as the interest rate on your credit card debt is higher than on your student loan, focus on clearing your credit card debt first. Over the long run, that will reduce the total amount of interest that you have to pay on your debt.
But what if the situation changes?
What if the interest on your student debt starts to creep up, and you find an amazing credit card deal? What do you do if your credit card costs 2.9% APR while your student debt stands at 4.9% APR?
Let's look at the advantages and disadvantages of the various student debt help options;
1) Focus on the credit card debt
IDEA: Continue paying both debts individually, making the minimum payment to your student debt while putting the rest of your cash towards your credit card. Once the credit card is repaid, use all of your income to repay your student loan.
REALITY: As long as the interest rate on your student loan is higher than your credit card, this option will cost you slightly more interest in the long run. But this remains the safest option. As you'll see below (option 4), it's generally much safer to owe money on a student loan than it is to owe money on a credit card.
2) Focus on both debts equally
IDEA: Continue paying both debts individually, but focus on repaying both of them at an equal pace.
REALITY: This is similar to option 1 above, the only difference being that it will cost you slightly less interest while the rate on the student loan is higher than the credit card debt.
3) Focus on the student debt
IDEA: Continue paying both debts individually, making the minimum payment to your credit card while putting the rest of your cash towards your student loan. Once your student loan is repaid, use all of your income to repay your remaining credit card debt.
REALITY: This option is just the reverse of option 1, but takes advantage of the fact that in our new example the student debt suffers interest at a higher rate. It will help you to save money on interest payments for as long as the rate of interest on your student debt is higher than on your credit card deal.
But it will remove more of your debt from the relatively save environment of a student loan at the same time as leaving more of your debt at the mercy of the commercial lending sector (this isn't always the best option, as shown below).
IDEA: Transfer the entire balance of your student loan to your credit card to take advantage of the lower APR. Using our new example, this would reduce the rate of interest on your student loan from 4.9% APR to the 2.9% APR offered by your credit card deal.
REALITY: This could be a risky option. Okay, at present is might allow you to save a small amount of interest on your total debt, but you have to consider the differences between credit card companies and student loan providers.
Most student loan schemes are run by government agencies or educational authorities. This might sound hard to believe but outright profit is not their number one aim. And because many of these schemes are government subsidised, they often have extremely good repayment terms. Often far better than the best credit cards on the market. And they don't usually impose such harsh penalties if you are late with a repayment.
In contrast, credit card companies exist to make money. The more money that they can draw out of their customers the happier their shareholders. So before you transfer your student debt to a credit card, you must think long and hard about it, because it's a one time only decision. In most countries, once you've repaid a student loan, you can't re-borrow the money.
How long will this low rate of 2.9% APR on your credit card last? Is it just an introductory offer that will last a few months and then revert to a much high rate of interest? Are there any penalties or restrictions in the small print.
And what if you miss a repayment? Most credit card companies will charge you a hefty fee if make a late repayment. And as if that's not enough, some will even transfer your debt to a much higher rate of interest just because you miss a repayment. So if either of these things happen it would wipe out all your potential savings immediately. And there would be nothing that you could do about it.
Other issues to consider; Filling up your credit card with student debt could affect your credit rating. In some countries, interest paid on student loans can be used to reduce your income for tax purposes (you can't do that with a credit card). The psychological issue - would you rather have two smaller loans or one large loan? Some people find it harder to get motivated when the task ahead of them appears to be larger.
Transfering student debt to a credit card could help you to save money but only if you make sure every payment is made on time and that you are committed to paying off the debt before the special offer interest rate ends. But it's a big risk and there's no way back if you run into problems.
Of all the options, when you have to choose between repaying credit card debt or a student loan, it's usually cheapest and almost always safest to focus on repaying your credit card debt first.
by Stuart Laing
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