Should You Pay Off a Student Loan With a 0% Interest Credit Card?
June 17, 2007 by Erik Folgate
Filed under College, Credit and Debt
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.
Having paid off college loans and currently working on graduate school loans, I feel your pain.
While I agree with much of your post, I disagree with your single minded focus on paying off student loans as soon as possible.
Lets say you are dealing with $10,000 in student loans.
$5000 is at 5% fixed for 20 years
$5000 is floating at 7.8%
You have the ability to pay all interest and have $10,000 towards principle or savings.
Keeping the two loans in place will cost you $640 in interest charges. From this number, one has a lot of choices to consider:
1. Is the interest tax deductible? If so, they may be costing you $500 in after tax dollars.
2. Savings gives you power and options. Instead of paying off the loans, you put the money in a saving account earning 4.5%. You will bring in $450 with an after tax take home of around $300.
Bottom line, keeping the loans in place costs you $200-300 per year.
What does the $300 get you:
1. Better credit ratings lead to lower mortgage costs, car loans, and insurance.
2. People who “need” money get it, but it costs them. Having 10K in the bank is great insurance against car repairs, medical bills, living arrangement issues.
My general rule:
1. Take “available” free cash flow and split it 50/50 until you have a reasonable cash cushion. How big a cushion you need depends on things like available family funds, dual incomes, stability of current job/pay propects. The more risk one has, the more they need cash on hand.
2. Once the cash savings reaches 3 months expenses, change the allocation to 75/25 debt/savings.
In my example, I would recommend keeping the fixed loan in place for a while. I would probably pay off the floating rate loan. Saving 100% until I got back to $10,000.
I cannot underestimate how much I have saved by maintaining a stellar credit rating. I crashed my car last year and my rates went down? WFT? When I needed a car loan and a mortgage, I had a lot of leverage with bankers and got the best deals possible.
Good luck to you and your friend.
I understand that you save money doing it the other way, but I am saying that the level of risk involved is not worth it to me for the extra $100 or $200 savings in a year.
Also, don’t believe the banks when they tell you that you have to keep debt around to have a good credit score. Look, you can get a good mortgage and low insurance rates without caring debt for no reason.
I agree with you to save up a couple of thousand dollars before you start paying off debt aggressively, but letting student loans linger around just doesn’t make practical sense to me.
I think personal finance is about more about the PERSON, not the FINANCE. Don’t always let the numbers dictate your decision. Do what your heart tells you is the right thing to do.
That is a great point I think a lot of peopl forget, even myself sometimes. You do have to do what is best for you and your family, even when it may not be the best option on paper it may be the best option for your real life situation.
What are you guys talking about? There is a much easier way to do this kind of thing.
First, get a credit card that can pay off your student loan and pay your student loan with that credit card.
Second if you have some credits left, but a lot of stuff, make sure everything is paid in full by the credit card
Third, file bankruptcy. And 7 years later you are clear with no debt and no bad record.