This is a question that a friend of mine asked me recently, and I thought it would be a good question to throw out there to the readers of Money Crashers. If you are in your twenties, it seems like you’re a weirdo if you DO NOT have a student loan. The reality is that college is not getting cheaper, and many of our parents did not pass along a college fund for us. I have about $18,000 in student loan debt, and my wife will have even more than that. She’s in physician assistant school right now, so her student loans will definitely be worth it in another 12 to 18 months. The National Center of Education Statistics shows that a little more than 50% of students hold student loans at an average of about $10,000.
So your out of college now, and the college loan lender is knocking on the door. They want you to start repaying the loan. What’s the best way to pay off this loan? My personal philosophy is that you should pay off credit card and student loan debt as quickly as possible. Do not play the interest game where you can invest the money that you would use to pay off the loan at a higher rate than the interest you are paying on the loan. The reason I think this is a completely bogus thing to do is because the people that argue this point never factor in the added risk involved and the taxes you will pay on the capital gains that both diminish your return to almost nothing.
My friend’s question is a little different. He intends on paying off his $4,000 student loan in a year. His question is whether he should pay that student loan off which is at 7% interest right now, and pay off the 0% interest credit card balance in a year. Well, the first thing you need to do is make sure that you can afford to make the $380 monthly payment that it will require to pay off the amount in one year. Do you already have enough left over in your budget to make that payment or will you need to get a second job or sell some stuff to pay it off in a year? Figure that out first, and then move on to the next step. The next step is deciding whether you should keep the loan where it is or transfer the money to the 0% credit card.
I answer questions as if it were me in the situation. I would keep the student loan where it is and aggressively pay it off within a year. The reason for this is that credit card companies are extremely sneaky. You need to make sure that 0% credit card offer does not have a hidden balance transfer fee built into it. Some credit cards will charge you a flat 3% fee just to make the balance transfer. Sometimes, you can negotiate with them, and they will waive the balance transfer fee. Also, credit card companies love to penalize you for making one slight error. If you are even one second late on your payment to a credit card, they will hit you with a $39 late fee AND they will void your 0% introductory interest rate offer and bump you to their normal rate of 11 to 19% interest. If this happens, then it was not worth it at all to transfer the student loan over to the credit card. Student loan companies are generally more forgiving when you are late on a payment. If there’s no balance transfer fee and you are meticulous about making credit card payments, then this could work out that you save a little bit of money from paying less interest while you pay off the money. However, my point is that many of us are not perfect when it comes to making a bill on time and credit card companies are sneaky when it comes to luring people into a 0% interest rate card. If you are looking to consolidate some existing credit card debt to a 0% interest rate card, I would definitely do that. The debt is already with a credit card company so there’s no added risk in bringing it to another card that acts the same way.
Pay the loan off with the existing student loan company in 10 to 12 months, and you won’t even think about the $200 bucks you could have saved with the 0% card. The risk involved with sending the money to the credit card company is enough to make me stay away from going that route.