Generally speaking knocking out your credit card debt before you pay off your student loans is the smartest financial move. This is because most credit card interest rates greatly exceed the interest rates on most student loans. That being said, before you decide on a strategy, there are a few factors that should be considered first.
Changing Interest Rates
Many student loans and credit cards have variable interest rates. As the economy changes the interest rate that you pay on your credit card or student loan can change. Typically, these changes are gradual, so a variable interest rate isn’t a huge consideration.
However, there are circumstances in which interest rates can change dramatically. For credit cards, it could be a case of a 0% promotional rate jumping up above 20% in a year. For student loans, the may options to refinance at lower interest rates, could mean a major drop in your interest rates.
If you are looking at a major change in interest rates, it is probably worth your time to do a little math. Suppose you have a credit card balance on a card that currently has 0% interest rate that will be jumping to 20%. On one hand you want to take advantage of the 0% rate, but on the other you really want to avoid paying 20%. In that instance, you might want to calculate how many months it will take to pay off the credit card balance. If it will take you 4 months to pay off the credit card, take advantage of your 0% rate until you have only 4 months left. At that point shift your focus back to the credit card to make sure you don’t get stuck with the huge interest rates.
Student Loan Forgiveness
If your student loans are federal loans, there are a number of forgiveness programs that should be on your radar. This is especially true if you have very low interest credit card debt and are considering paying off your student loan first.
The two most popular student loan programs are the standard loan forgiveness and public service loan forgiveness. The standard loan forgiveness happens after 20 years of payments on PAYE or 25 years worth of payments on IBR. Regardless of which order you plan on paying off your debts, getting on an income based plan could be a good idea.
Public service loan forgiveness happens after just 10 years worth of payments on an income driven plan. This could result in a huge savings for those who work in government or for a non-profit. Before you plan on going this route, be sure you understand the details of public service student loan forgiveness and get started on the right repayment plan.
With these forgiveness programs in place, paying off your credit card first, even if it has a lower interest rate, may make sense. Of course, this will depend upon your balance, your employment, and your income; but it is something to consider.
Credit Score Consequences
One of the big considerations in determining your credit score is the amount of revolving credit you have available. The most common type of revolving credit is a credit card. If your credit card debt is low compared to your available credit, it is very good for your score. Surprisingly, paying off your student loans will not make as big of a difference in your credit score. If you are planning a major purchase, such as a house, and you have some money to pay down debt to run up your credit score, paying off the credit card first will likely get you the most bang for your buck.
If you are planning an aggressive debt repayment plan, it hopefully means that there is no bankruptcy in your future. However, if there is a possibility that you may be filing for bankruptcy in the future, you may want to shift your attention towards your student loans. This is because credit card debt can be dealt with in a standard bankruptcy proceeding, but student loan debt is very difficult to discharge and requires its own special proceeding. If you are exploring this option and curious about how these rules affect your individual situation, you may want to consult a bankruptcy specialist.
Lets say your credit card and student loans have the same interest rate. Which do you pay off first? If all other things were equal, you would want to pay off your credit card first. This is because the interest that you pay on your student loans can be deducted from your taxes. It doesn’t necessarily make a huge difference as it is a deduction and not a credit, but this difference can make next April 15 go a little better for you.
The Big Picture
When it comes to paying off debt, there are many strategies and approaches out there. While the two most common are probably the snowball and avalanche methods, there is nothing wrong with coming up with your own. The important thing is to recognize that having a bunch of debt is very expensive, because you pay interest each month. The more debt you can pay off, the less interest you will owe. The sooner you get it paid off, the more you will save in the long run. Whether you start with a student loan or a credit card, the ultimate goal is to get it all paid off as soon as possible. Find the path you think gets you there the quickest and go for it.