Wednesday, September 21, 2005

Should I pay off the credit cards or the student loans first?

I made a decision when I started aggressively paying off my debt that the credit cards would come before the student loans. It made sense at the time because I was paying more every month in interest towards my credit card than I was towards my student loans. Right now though, I find that I am paying more interest towards my government subsidized student loans than I am towards my credit card. I started mulling over in my head the different approaches I could take to this situation and decided I needed to consider all of the pros/cons of each different scenario.

Here is the current situation:

Student loans: $9,717.02 5.125% APR $41.49/month
Credit Cards: $12,999 3.5% APR $37.91/month

Scenario 1: Stay the course

I could continue paying each separately, making the minimum payment to the student loans while paying any additional income towards the credit card. Once the credit card is paid off, focus all additional income towards paying off the student loans.

Scenario 2: Split the bill

I could continue paying each off separately but focus an equal level of aggressiveness towards both loans.

Scenario 3: Consolidate

I could transfer the entire balance of the student loans to the credit card, using a low APR promotional balance transfer. I would pay a one-time fee of $50 and reduce the APR to 2.99%. The lower APR rate would save $200/year.


After juggling each possible scenario in my head, I’m thinking that the best route of action would be to stay the course. Why?

1) Student loan interest can be used as a tax write-off. Essentially, any interest (up to $2,500) that is being paid towards your student loans can be deducted from your taxes. You cannot do this with credit cards! Ultimately, for me, the tax benefits would be $90 off of my taxes but for some people it can be up to $350.

2) Credit card companies are evil. They are in business to make money off of you. Thus, having debt with credit card companies is a much riskier business. The federal government will be more forgiving of you if you miss a payment or are late on a payment. With the credit card company, if you are ever late on a payment they can jack up your interest rate to as high as it can go. If that ever happened to me I would be screwed because at 24% APR on the amount of debt I have right now I would be paying $273 every month in interest.

3) If I transferred the balance of my student loans to my credit cards my debt to credit limit ration would jump back up to nearly 100%. This would ruin my credit rating.

4) Not to mention the fact that it would be so depressing to see the credit card debt go back up so high after making such an effort to pay it down.

But why oh why is my interest rate on my student loans so high?!?

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11 comments:

mbhunter said...

I think you're making a good decision. If you're trying to save as much interest as you can (ignoring everything else) then you'd be better throwing as much of the extra money as you can at the debt with the higher interest rate -- in this case, the student loan. Even with your deduction, it's still probably going to be a higher rate than the CC rate.

But paying down your CC faster does reduce the risk of missing a payment and having your rate skyrocket.

The main point is that your paying down the debts, and how you do it is less important than the fact that you are doing it. :)

(By the way, I put one of your posts in the Carnival of Personal Finance. Hope you don't mind!)

mbhunter said...

Oops ... meant Carnival of Debt Reduction!

Chris said...

Smaller goals are easier to see through - focusing your power on the CC and then the SL breaks it up enough that the goals actually seem feasible.

Don't think that the government loans are any less evil than the CC's. Remember, they are charging you even more interest right now. There is no debt that is 'friendly' :)

annab said...

I think it's good to pay the CC off first -- you can always have your student loans deferred for 1) hardship or 2) taking a few classes. But you can't for the CC.

Anyway, love the blog.

annab

Anonymous said...

Stick with the CC first, you've done so well so far you don't want to lose focus. If you move student loan to a credit card it might depress you and you will lose your motivation! Student loans interest rates are fixed at least until next year and credit cards are adjustible rates I dont think its worth the risk,,,just my opinion. :)

Bailey said...

Your student loan APR is a bit high.

I would pay off the higher APR first. If have that 3.5% APR locked in for good, then just pay the minimum. You can make more than 3.5% by investing the rest, so it is like free money that you are getting!

KJ said...

Don't feel too bad about your student loan APR... mine is 8.25%!!! Yikes!

abileneblues said...

I tend not to look at the APR as to what could happen. I think that you would have more options during unexpected financially tough situations with your student loans (even though they would not be forgiven in a bankruptcy, if I recall correctly).

I, personally, would (and did) pay off credit card debt before student loans.

Anonymous said...

If your student loans are Federal direct student loans, don't transfer them to a credit card. I believe if you do that you won't be able to use the Fedral Student Loan Consolidation program to consolidate them. If you had consolidated yours through this program before July you would have locked in the low rate. I just wanted to post this in case it would help you in the future. http://www.loanconsolidation.ed.gov/

Anonymous said...

tips for reducing your student loans:
1) consolidate your loans like the others have already recommended
2) sign up for direct debit. i was able to shave another 0.25% off my interest just for that, bringing my interest rate down to an incredibly low 2.65%. they don't advertise the lower rate with direct debit, though. i didn't find out until i called and a customer service rep told me.

Ways To Pay off Debt said...

Your student loan APR is a bit high.
JKohn from:
Debt managment and How to pay off debt