Credit Cards vs. Student Loans: Which Debt to Pay?
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After home and car loans, student loans and credit cards are clearly America's borrowing method of choice.
Your credit card rate is largely dependent on your credit score; whereas your student loan rate is either fixed by the Feds, your school, or your IQ (sort of).
So, when it's payback time and you have some extra money sitting around, should you put it towards paying down credit card debt or student loans?
Here's the tale of the tape:
| Credit Cards | Student Loans | |
| Age | 41 - The modern era of paying with plastic took hold in 1958 with credit cards launched separately by Visa (then BankAmericard) and American Express. | 41 - With roots in the GI Bill of 1944, the Federal student aid program took off in 1958 with the National Defense Student Loan Program. |
| Height | 14.43% - Average interest for all credit cards accounts assessed interest in May 2009 (Federal Reserve). | 5.60% to 8.50% - For federal loans disbursed after July 1, 2006, a range of fixed rate options are available dependent on the loan program. |
| Weight | $10,679 - Average outstanding credit card debt for card-carrying households (Nilson Report). | $24,651 - Average cumulative federal, state, college and private loan debt held by graduating students with debt in 2008 (FinaAid.org). |
| Utility | Credit cards are built for consumption. The world of material goods and services—from medical procedures to lavish vacations to everyday items—is at your fingertips, even if out of financial reach. | Among the loans most difficult to discharge in bankruptcy, student loans finance fantastic educations but don't buy ANYTHING of value to anyone except the borrower. |
| Advantage | No need to carry cash or checks for shopping. If you pay your bill in full, as 42% of U.S. households do, then there's no interest! | Covers the remarkable upfront cost of higher-education. An added perk, interest is tax deductible on qualified loans up to $2,500, making an already low-interest rate even lower. |
| Record | More than 1.4 million consumer bankruptcies are expected to filed in 2009 (American Bankruptcy Institute). Our guess is nearly all are carrying credit card debt. | In 2006, nearly 62% of U.S. high school graduates enrolled in college (PostSecondary.org). College degree holders earned an average of $57,181 in 2007 compared to $31,286 for those who only completed high school (Census Bureau). |
| Legislative Moment | The 2009 Credit Card Accountability Responsibility and Disclosure (CARD) Act limits issuers' ability to raise rates, eliminates two-cycle billing and calls for payments to be applied to higher rates first. Its efficacy remains to be seen as card companies are raising rates and cutting lines before the law ramps up in February 2010. | After the College Cost Reduction Act of 2007, the market for private student loans dried up—by design—and pushed more borrowers to federal loans. Many students were left high and dry when they exhausted federal loan limits and couldn't find another lender. |
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Now that you've read the facts, it's time to make your decision. Which would you pay down with extra cash? |
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| Why Pay Me? | Credit card debt offers no benefit. It may finance computers and vacations, but those costs can double with interest. Unless you have a teaser rate or a low-fixed rate card (rare and rarer), the interest will be higher than that carried by most other debts. | Student loan debt is monstrous and an eyesore. Despite the interest tax-deduction, staring at tens of thousands in debt every month starts to sting. Whittling down a major debt gives you confidence to push the balance down faster. |
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It does seem as though tackling the higher-interest credit card debt first is the way to go. As noted, some student loan interest is tax-deductible, so it's not quite as onerous.
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Under what circumstances is student loan interest tax-deductible? I feel like my lender intentionally left me in the dark regarding this.
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Student loan interest is deductible up to $2,500 with a phaseout beginning at $70k (individual) and $145k (joint). See the complete rules here - http://www.irs.gov/publications/p970/ch04.html - and be sure to get form 1098-E from your lender.
If you are above the income level, get the 1098-E anyway, you never know. Once you've missed the deadline for the form (which must come from the lender), you can still make the deduction if you have documentation of your interest. You just won't have the hard proof.
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This should be a non-question/issue. You always pay down the instrument with the highest interest rate first - that is unless you enjoy paying more overall. I don't know of many credit cards that have interest rates lower than student loans - so 99.44% of the time, always pay the max you can afford to pay off the credit card first, with minimum required payment to the student loan.
I cannot get over the arguments that some of the experts put forth regarding paying off things that have lower balances/rates first for a "confidence boost". People who find themselves carrying credit card debt from one month to the next got into the problem situation because of their poor habits in the past. Why advise them to make more financial mistakes in paying it off?
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alderwoodct replied 15 days ago
Howard, 3 of my cards have interest rates of less than 3%, while 5 of my law school loans (totaling about $50k) are between 7% and 8%. Clearly, you would say to pay the student loan first.
However, and especially in this economy, it's important to remember that our jobs are not completely secure. If I lose my job, I can defer law school loans, while the same cannot be said for credit card debt.
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