July 22nd, 2013
**Today?s guest post is contributed by Fiona.**
Many of us carry both student loan debt and credit card debt. As a society, our indebtedness is deep: collectively, we owe over $1 trillion for student loans and over $850 trillion on credit cards. If we were to break that down further, the average credit card debt is approximately $15,000, and the average student loan debt is around $32,000. These numbers are sobering, especially at the individual level.
While each person?s situation regarding student loans and credit card debt is different, it can be challenging to figure out what to pay off first when you have both types of debt. There are pros and cons to paying off one or the other first.
Should You Pay Off Student Loans First?
Student loans are sometimes thought of as ?good debt? because they are considered to be an investment in oneself. Higher education has been shown to lead to higher paying jobs, and that has been true even in this current recession, where college graduates are outpacing high school graduates in rates of employment. But that doesn?t necessarily help the student loan borrower when they?re facing a mountain of student loan debt.
Here?s what student loan borrowers need to know: student loans have several advantages that may actually lead you to consider paying off other types of debt first. Although the amounts involved with student loans are quite intimidating and high, they are considered installment loans by the credit agencies, which means they won?t impact your score as much as credit card debt. In fact, if you choose to defer or put your loan into forbearance, it will not hurt your credit score.
One little-known fact about installment loans is that if you choose to pay them off early, that may actually hurt you. A student loan payment is a regular monthly payment, and lenders do not have the ability to add on risk or credit. When you pay off a student loan early, they are missing out on the interest and your credit score may go down slightly if this is the only installment loan you have on your debt profile. On the other hand, the psychological relief of paying off your student loan may more than make up for it.
Interest rates for student loans are also lower than most credit cards. The federal student loan interest rates for subsidized Stafford loans recently went up from 3.4% to 6.8%. But still, most student loan interest rates are lower than credit card interest rates. Just keep in mind that credit card debt can be forgiven while student loans can usually not be forgiven or discharged through bankruptcy.
Should You Pay Off Credit Cards First?
For many lenders, credit cards are considered ?bad? debt, since they are most often used to purchase consumer goods and experiences rather than making investments in the future that could conceivably help raise your income.
Credit cards are more flexible than student loans in that you can add on more debt. They provide flexibility for emergencies, but this comes at a cost with generally higher interest rates.
The best thing to do with credit card debt is to pay it off as quickly as possible, but if the funds are not available, pay the minimum amount every month to avoid expensive late charges. Consider the finance fees on your balance to be an incentive to pay off your monthly balance.
Depending on your credit card, interest rates can be as high as 20% (or higher), making it a no-brainer to pay this off first compared to a student loan. And unlike student loans, if you are able to make regular payments and pay off your credit card, your credit score improves significantly.
Bottom Line: Compare Interest Rates
In general, it will be a better idea to pay off credit cards first, as your interest rates will be much, much higher. However, one option available is transferring your credit card balance to a card with a promotional 0% interest rate, but you?ll need to be certain you can pay off that balance during the promotional period.
No matter what kind of debt you have, don?t pay off debt with more debt. Don?t pay student loan debt with credit card debt, or vice versa. Let?s say you decide to pay your credit card debt in one lump sum with your student loan. Now you?ve just added to the amount of money you can?t discharge in bankruptcy. On the flip side, paying a student loan with a credit card can also hurt you if you can?t pay off your balance at the end of the month, adding to your interest charges.
Instead, educate yourself and create a proactive plan so you won?t find yourself in a hard spot with either your student loan debt or your credit card debt. Make it a regular habit to pay off a certain amount towards both, and before you know it, your credit score will be golden and you?ll be celebrating your freedom from debt!
Fiona Lee is a personal finance writer at ReadyForZero, a site dedicated to helping Americans manage and pay off their debt ? for free.
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