Janice Lozano
Millions of Americans struggle with the decision of whether to pay off credit cards or student loans first. This decision is complex and depends on an individual's financial situation. Generally, credit card debt takes precedence over student loan repayment due to higher interest rates, the negative impact on credit scores, and the inability to deduct credit card interest. However, it is crucial to stay current on student loan payments to avoid defaulting, which can lead to fees, damaged credit, and potential legal consequences. Additionally, student loans are often considered 'good debt as they represent an investment in one's future, and certain repayment plans and forgiveness programs are available.
| Characteristics | Values |
|---|---|
| Interest rates | Credit cards tend to have higher interest rates than student loans. The average credit card APR as of February 2023 was 20.92%. |
| Credit score | Paying off credit card debt can improve your credit score by reducing your credit utilization. |
| Late fees | Missing a payment on a credit card can result in late fees, which can add up over time. |
| Tax benefits | You can deduct up to $2,500 of qualified student loan interest each year, which is not possible with credit card interest. |
| Debt forgiveness | Certain student loan forgiveness programs are available, such as Public Service Loan Forgiveness, that may not be applicable to credit card debt. |
| Repayment assistance | A growing number of employers are offering student loan repayment assistance, while it is less likely that they will pay off your credit card debt. |
| Consolidation | You may be able to consolidate multiple student loans into one to simplify repayment and lower the average interest rate. |
| Minimum payments | Making the minimum payment on a student loan while paying off the credit card debt with higher interest can save you money in the long run. |
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What You'll Learn
Credit cards have higher interest rates
Credit cards typically have higher interest rates than student loans. As of February 2023, the average credit card APR was 20.92%, according to Federal Reserve data. In contrast, the average interest rate for student loans is significantly lower. For example, the Grad PLUS loan rate is 7.6%.
Due to the higher interest rates on credit cards, it is generally recommended to prioritize paying off credit card debt before focusing on student loans. This approach can save you money in the long run, as you will pay less total interest on your credit card debt. Additionally, paying off credit card debt can improve your credit score by reducing your credit utilization.
However, it is important to stay current on your student loan payments while prioritizing credit card debt. Falling behind on student loan payments can have negative consequences, such as fees, damage to your credit score, and potential lawsuits.
To effectively manage your credit card debt, you can consider options such as balance transfer credit cards, which offer an introductory period of 0% APR, or personal loans, which typically have lower interest rates than credit cards.
By focusing on paying off your credit card debt first, you can take advantage of the lower interest rates associated with student loans and improve your overall financial situation.
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Student loans are considered 'good' debt
Student loans are considered "good debt" because they represent an investment in your future. A college education increases your lifetime earning potential, which is why student loans are considered good debt rather than bad debt. According to the US Bureau of Labor Statistics, people with bachelor's degrees earned an average of $1,493 per week in 2023, compared to $899 weekly for those with high school diplomas.
Student loans also carry much lower interest rates than credit cards, so you will pay less total interest over the life of your student loan than you would on a credit card. Federal student loans come in two types: subsidized and unsubsidized. With subsidized loans, interest does not accrue until after graduation, whereas with unsubsidized loans, interest accrues once the loan is disbursed.
Student loan debt can be a nightmare to pay off, and it can cause financial stress for many students and recent graduates. However, student loans can help you build a credit history, showing lenders that you are a responsible borrower. Additionally, some employers are offering student loan repayment assistance, which can be a factor in your job hunt.
While student loans are generally considered good debt, there are potential downsides. Choosing the wrong degree could lead to a negative return on investment, and unemployment or underemployment after graduation can lead to serious credit issues if you cannot afford to repay your loans.
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Credit card late fees add up
Credit card late fees can add up quickly, and they can have a significant impact on your finances. When you miss a payment on a credit card, you will typically be charged a late fee, which is added to your outstanding balance. This late fee can then itself accrue interest, and you may be charged additional late fees on top of it if you continue to miss payments. Late fees have been increasing over time, with the average late fee charged by major issuers growing from $23 at the end of 2010 to $32 in 2022.
Late fees are just one of many punitive measures that credit card companies may impose on consumers who miss payments. Other consequences can include extra interest charges, the loss of grace periods, negative credit reporting, reductions in credit limits, and higher interest rates on future purchases. These additional charges and penalties can significantly increase the cost of credit card debt, making it even more challenging for individuals to get out of debt.
To avoid late fees and the potential negative impact on your credit score, it is essential to make timely payments each month before your grace period expires. Setting up automatic payments can be a helpful way to ensure that you don't forget to pay your bills. However, if you are experiencing financial hardship, it is important to contact your credit card issuer to discuss your options and explore any financial hardship programs they may offer.
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Student loan repayment assistance from employers
When deciding whether to pay off credit cards or student loans first, it's important to consider the interest rates on both types of debt. Credit cards typically have higher interest rates than student loans, so it often makes financial sense to prioritize paying off credit card debt first. This can save you money on interest and potentially improve your credit score by reducing your credit utilization. However, it's important to stay current on your student loan payments to avoid penalties and damage to your credit.
Now, let's discuss student loan repayment assistance from employers:
There are different ways employers can structure their student loan repayment programs. One option is to make direct contributions to employees' student loans, up to the annual limit of $5,250. These contributions are income tax-free for employees and payroll tax-free for employers when provided as part of an educational assistance program. Another option is to offer matching contributions to employees' retirement accounts when they make student loan payments. This allows employees to build their retirement savings while paying off their student loans.
Student loan repayment benefits can have a significant impact on employees' financial well-being and productivity. Studies have shown that employees with financial worries may spend a considerable amount of time distracted at work, leading to potential losses for employers. By offering student loan repayment assistance, employers can help reduce financial stress and improve employee retention, morale, and productivity. Additionally, employees may be more likely to commit to an employer for a longer period when such benefits are offered.
When considering student loan repayment assistance, it's important to check with your HR department to understand if this benefit is available and what the specific qualifications and requirements are. It's also worth considering this benefit when job hunting, as it can be a valuable perk that contributes to your overall financial wellness.
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Credit card debt is easier to default on
Credit card debt is generally easier to default on than student loan debt. This is because credit cards tend to have higher interest rates than student loans, making it more expensive to maintain credit card debt over time. According to Federal Reserve data, the average credit card APR as of February 2023 was 20.92%, whereas the average interest rate for student loans tends to be significantly lower.
The high interest rates associated with credit cards can lead to a cycle of debt that is difficult to escape. Late fees and penalties for missing payments can also add up quickly, making it even harder to catch up on payments. In contrast, student loans often offer more flexibility, such as income-driven repayment plans or payment pauses in the case of financial hardship.
Additionally, credit card debt is often considered "bad" debt, as it typically does not provide the same long-term benefits as student loans, which are seen as an investment in your future. Student loans may also qualify for tax deductions on the interest paid, whereas credit card interest is generally not tax-deductible.
Furthermore, credit card debt can impact your credit score more significantly than student loan debt. Reducing credit card debt can directly improve your credit utilization ratio, which is a major factor in determining credit scores. A better credit score can lead to better loan terms in the future, including lower interest rates and more favourable repayment options.
While it is important to stay current on both credit card and student loan payments, prioritizing the payoff of credit card debt first can save you money in interest and improve your overall financial health. This, in turn, can make it easier to manage your student loan debt in the long run.
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Frequently asked questions
Generally, it is recommended to pay off credit card debt first, as credit cards tend to have higher interest rates than student loans. By paying off credit card debt first, you can save money on interest and potentially improve your credit score.
One strategy is to get a balance transfer credit card, which allows you to consolidate multiple credit card balances onto a single card, potentially with a 0% APR for a promotional period. Another option is to negotiate a lower interest rate with your credit card company, especially if you have a history of on-time payments. You can also consider taking out a personal loan with a lower interest rate to pay off your credit card debt.
Student loans are often considered "good" debt because they represent an investment in your future. Additionally, you may qualify for tax deductions on the interest paid on student loans, which can reduce your taxable income. However, it's important to prioritize paying off credit card debt with higher interest rates to save money in the long run.
Falling behind on payments can negatively impact your credit score and make it more difficult to obtain credit in the future. It is crucial to make on-time payments and stay current on your debts. Creating a budget and building an emergency fund can help you stay on track with your payments and avoid relying on credit cards for unexpected expenses.
