What Should I Pay Off First: My Credit Card Debt or Student Loans?

 May 4, 2020
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When it comes to paying off student loans and credit card debt, credit card debt should generally be paid off first. Credit card debt typically has higher interest rates and, unlike student loans, it doesn’t have the same repayment options to make lower payments if necessary or take a break from payments altogether if you were to hit a financial snag.

Still, like many financial decisions, the choice between student loans and credit card debt is a personal one. There are a number of factors you’ll want to consider when deciding which order to pay off your debts.

Student loans and credit card debt: 6 questions to ask
Credit card vs. student loan debt: What experts say
7 tips to lower your debt balances

Student loans and credit card debt: 6 questions to ask

1. How much student loan and credit card debt do I have?

Compare how much student loan debt you have versus credit card debt as you decide how much to pay and in which order. While you generally should pay off credit card debt first, you may decide to pay off student loan debt first if, for instance, you are within a few payments of complete payoff.

2. Which debt costs more?

Let’s say you have $5,000 in student loan debt and $5,000 in credit card debt that you’ll pay in the same time frame of five years. In that instance, you’d want to look at the interest rate for each type of debt.

If the student loan was borrowed at a rate of 6.08%, which is the current federal direct unsubsidized loan interest rate for graduate students, you’d pay $811 in interest in addition to the $5,000 principal. For the same $5,000 in credit card debt, you’d pay $2,116 in interest over five years, assuming you had the current average APR of 14.87%.

In general, credit card debt costs more to keep. Plus, the $811 in interest charged on the student loan is tax deductible with the student loan interest deduction — as long as your modified adjusted gross income is under $85,000 if you’re single or under $170,000 if you’re filing a joint return.

3. Which debt is easier to repay?

Federal student loans offer several options for making reduced payments or taking breaks from making payments altogether, known as deferment or forbearance. For reduced payments, you can either extend payments to a longer repayment term or choose a repayment plan based on your income level. You can temporarily pause your payments altogether for specific reasons like your in-school status or loss of employment. Private student loan lenders may offer deferment or forbearance, as well.

Credit cards generally don’t offer deferment or forbearance options, but they do have low minimum payments that are usually around $25 or 3% of the total balance. While you should pay above the minimum whenever possible, it’s convenient to only have to pay a small percentage of your total balance if you’re in financially tight times.

Options for a break from payments differ among credit card companies. Call your credit card company if you are having trouble making payments.

4. What happens if I miss a payment?

Federal student loan services don’t report student loan delinquencies to national credit bureaus until you’re 90 days past due. A credit card company or private student lender, on the other hand, can report a missed payment as soon as you’re 30 days late on payments, which will damage your credit score.

After you are more than 270 days (about nine months of payments) late on a federal student loan, you may go into default on a student loan. At this point, the IRS can start garnishing your tax refund and wages.

Since there are a variety of solutions when you miss a payment, from permitted payment breaks to income-driven default rehabilitation payments, discussing options with lenders or services is vital to avoid credit score drops, lawsuits and possible employment difficulties if applying for a new job.

5. Is either ‘good’ debt?

Lenders view student loans and credit card debt in very different ways when it comes to your credit score, which can determine whether you qualify for a new credit card or a mortgage.

For general credit scoring, credit cards count in a category called revolving debt, which is essentially a renewable loan. If you owe $450 on a $500 credit limit, you’d be using 90% of your available balance. This doesn’t look good to creditors, said Randy Garner, certified financial planner and certified public accountant at Garnett Planning. However, if you still owed 90% of your student loan, it wouldn’t affect your credit score as much.

The second measure, debt-to-income ratio, can be equally affected by both types of debt. Your debt-to-income ratio is the amount of your monthly payments compared to your total monthly income. Thus, a $300 monthly student loan payment could affect you more than five credit card minimum payments of $50 each that total $250. This ratio generally only affects major lending, such as mortgages or auto loans.

6. Can you cancel either debt?

The main way federal student loans are cancelled is through forgiveness programs, such as Public Service Loan Forgiveness, which allows borrowers in certain fields to have their federal student loan debts forgiven after making 120 qualifying payments, and income-driven repayment plans, which forgive the remaining amount of debt after 20 to 25 years of payments under the program.

Credit card debt can be settled or combined and replaced by a consolidation loan. Or, it may be discharged in bankruptcy. Federal student loans can only be discharged in bankruptcy under rare circumstances, such as if the debt causes you to be unable to maintain a minimum standard of living.

Credit card vs. student loan debt: What experts say

In almost all cases, experts agree that you should pay off credit cards before student loan debt because of both credit factors and the ease of taking a break from payments when you can’t afford them.

However, there are times when it may make sense to pay off credit cards or other non-student loan debt first, said Garner. For instance, Garner mentioned an instance where he paid off a car payment of $250 years ago. No longer having that payment could give him a better debt-to-income ratio for qualifying for a mortgage, he said. Paying off a credit card that is close to being paid off may do the same thing.

Kelley Long, a certified financial planner and personal financial coach at Financial Finesse in Chicago, agrees that it’s generally best to pay off credit cards first — especially if the loans are federal student loans because of all the protections offered for difficult economic circumstances.

But an exception, Long said, is if you happen to have a low promotional interest rate for your credit card. For example, say you sign up for a credit card with a 0% promotional rate that will jump in interest rate from 0% to 18% if not paid off in 18 months. So long as you can pay off the card sometime before the 18-month period ends, it won’t matter if you spend the first few months focused on paying off your student loans.

7 tips to lower your debt balances

Whether it’s student loan or credit card debt, there are actions you can take to lower your balances and get your finances in order.

  • Keep a detailed budget. One of the starting points when you want to get your economic life in order is planning. Write down every expense currently in your life so you can review your budget to see what you can cut.
  • Don’t get your own place. Living with friends and family is a simple way to keep expenses down. Review your rental expenses carefully before choosing a new home.
  • Avoid addictive or mindless spending. Shopping, gambling or even dining out without thinking about it can easily cut into your funds. Before spending, make sure you’re aware of how even the seemingly small expenses can add up. “Never save your credit card information in online shopping websites or apps or enable one-click purchasing,” said Bruce McClary, vice president of marketing at the National Foundation for Credit Counseling (NFCC). “The more barriers you add to the process, the less likely you’ll end up with impulse purchases you regret later.”
  • Consider refinancing to get a lower interest rate. Refinancing student loan debt or credit card debt can help save money in both situations by securing a lower interest rate, assuming you have a good enough credit score to qualify. For credit cards, be aware that there may be an initial balance fee.
  • Get a side hustle to pay more than the minimum monthly payment. A side hustle, even if it’s for just a few hours per week, can help you pay down debt much faster. A side hustle can be as simple as a seasonal holiday job or more long term, like consulting in your field.
  • Avoid taking a break from payments on student loans unless you really need it. When you take an excused break from monthly payments via forbearance, interest will keep building, meaning your debt will be even larger when you start making payments again. Consider paying a smaller amount during forbearance or choosing an income-driven repayment plan instead.
  • Use credit card rewards and rebate offers online to pay down balances. Sites like upromise.com and Rakuten.com offer cash rebate programs for cashback on online and sometimes in-store purchases that can be used to pay off your student loans or credit card balances. Credit card rewards can help you pay down your balance if you avoid overspending.

Kat Tretina contributed to this report.

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