Ibrahim Gardner
Millions of Americans struggle with the burden of student loans and credit card debt. The question of which to pay off first is a complex one, with no one-size-fits-all answer. However, a common approach is to prioritize paying off credit card debt first due to its typically higher interest rates. By reducing credit card debt, individuals can save money on interest and potentially improve their credit scores. Subsequently, they can focus on repaying student loans, which often carry lower interest rates and are considered a 'good' debt as they represent an investment in one's future.
| Characteristics | Values |
|---|---|
| Interest Rates | Credit cards tend to have higher interest rates than student loans. |
| Average Interest Rate (as of February 2023) | Credit cards: 20.92% |
| Average Interest Rate (as of February 2023) | Personal loans: 11.48% |
| Average Interest Rate (as of July 2017) | Credit cards: 16.06% |
| Average Student Loan Debt (for Americans aged 25-34, as of Q4 2020) | $33,818 |
| Average Credit Card Debt (for Americans under 35, as of Q4 2020) | $3,660 |
| Credit Score Impact | Paying off credit card debt can improve your credit score by reducing credit utilization. |
| Tax Benefits | You may be able to deduct up to $2,500 of qualified student loan interest annually. |
| Debt Forgiveness | Certain student loan forgiveness programs exist, while it's unlikely that an employer will pay off your credit card debt. |
| Debt Consolidation | Debt consolidation is an option for student loans but may have drawbacks, such as extended repayment terms and potential costs. |
| Balance Transfer Cards | Balance transfer cards can offer 0% APR for a promotional period, helping to pay off debt interest-free. |
| Recommended Approach | Prioritize paying off credit card debt first due to higher interest rates, then focus on student loans. |
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What You'll Learn
Credit cards have higher interest rates than student loans
Credit cards tend to have higher interest rates than student loans. As of February 2023, the average credit card APR was 20.92%, while the average interest rate for a 24-month personal loan was 11.48%. Therefore, it often makes financial sense to prioritise paying off credit card debt first, as it will save you more money over time.
The higher interest rates on credit cards mean that debt can accumulate faster than on student loans. By paying off credit card debt first, you can reduce the amount of interest you pay overall. Additionally, paying off credit card debt can improve your credit score by reducing your credit utilisation. This can be a quick way to boost your credit profile.
However, it is important to stay current on your student loan payments while prioritising credit card debt. Missing payments on credit cards can result in late fees. Meanwhile, student loan deferment or forbearance can lead to paying more over the life of the loan due to accruing interest. Therefore, it is crucial to balance paying off credit card debt with staying on top of student loan payments.
If you have multiple credit cards, there are different strategies you can use to prioritise which card to pay off first. One approach is to focus on the card with the highest interest rate to save the most money. Another method is to start with the card with the smallest balance to get a quick psychological boost from paying off a card faster.
Consolidating credit card debt through a balance transfer to a lower-interest card or a personal loan can help simplify repayment. However, it is important to be cautious, as introductory interest rates may expire, leading to higher rates later on. Additionally, consolidating debt can extend repayment terms, meaning you may be paying off the debt for a more extended period.
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Student loans are considered good debt
When deciding which to pay off first between credit cards and student loans, it is generally advised to prioritize credit card payoff. This is because credit cards often 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.
Student loans are often considered "good debt" because they represent an investment in your future. Here are some reasons why student loans are considered good debt:
- Higher future earning potential: A college education can lead to increased lifetime earning potential. Data from the U.S. Bureau of Labor Statistics shows that educational attainment leads to higher earnings. For example, individuals with a bachelor's degree earned an average of $1,493 per week in 2023, compared to $899 per week for those with a high school diploma.
- Long-term benefits: Student loans are considered good debt due to their potential for long-term benefits, including increased earning potential and opportunities. A college degree can provide advantages that may not be solely financial, such as networking opportunities, personal growth, and specialized knowledge.
- Lower interest rates: Student loans typically have lower interest rates compared to credit cards. Lower interest rates make student loans more financially attractive and manageable in the long run.
- Flexible repayment options: Student loans often offer flexible repayment plans, including income-driven repayment plans and the ability to pause payments in certain circumstances, such as large-scale disasters or economic downturns.
- Tax deductions: In some cases, you may be able to deduct a portion of your student loan interest on your tax returns, further reducing the overall cost of the loan.
While student loans are generally considered good debt, it's important to recognize that there are potential downsides. Choosing the wrong degree or experiencing unemployment after graduation can lead to a negative return on investment. Additionally, the financial stress of long-term loan obligations can impact an individual's ability to achieve other financial goals.
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Credit card debt impacts your credit score
Credit card debt can have a significant impact on your credit score. Lenders consider debt management experience a sign of creditworthiness, and credit scoring systems such as the FICO® Score and VantageScore encapsulate this experience using the length of your credit history. Credit scores factor in the ages of your oldest and newest credit accounts and the average age of all credit accounts on your report.
Credit card debt can also affect your credit utilization rate, which is the ratio between the amount of debt you owe on a credit card and the card's credit limit. A high credit utilization rate can negatively impact your credit score, as it may indicate that you are living beyond your means. It is recommended to keep your credit utilization at or below 30% to maintain a good credit score.
Additionally, consistently paying your credit card bills on time is crucial for maintaining a good credit score. Credit card companies may report late payments to credit bureaus, which can negatively affect your creditworthiness.
The type of credit card you choose can also impact your credit score. For example, a low, fixed-rate credit card is generally better than a low, variable-rate credit card, as variable-rate cards can change regularly and without notice.
Finally, opening and closing credit card accounts can also impact your credit score. Opening multiple new credit card accounts can shorten the average age of your credit accounts, which could negatively affect your score. Closing credit card accounts can also decrease your overall credit utilization, potentially leading to a lower credit score.
In summary, credit card debt can impact your credit score through credit utilization, on-time payments, the type of credit card, and the opening and closing of accounts. By managing credit card debt effectively and making informed choices, individuals can maintain and improve their credit scores.
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Balance transfer cards can help pay off credit card debt
Credit card debt can accumulate quickly, especially after the holiday season. The average credit card APR is 16.28%, but this can be even higher if you have a poor credit score. These interest charges can hinder your ability to repay debt since any payments you make go toward your principal balance and interest.
Balance transfer cards can help you tackle this debt without the burden of expensive interest charges. By transferring your credit card debt to a balance transfer card, you can benefit from promotional periods of low or 0% interest. This means that a greater portion of your payments will go toward the principal balance rather than interest, helping you to pay off your debt faster and save money.
For example, if you have a $3,000 balance on a credit card with a 15% interest rate, it would take 14 months to pay off with monthly payments of $250, plus over $270 in interest. However, by transferring that balance to a 0% interest card with a 3% transfer fee, you would pay off the debt in 12 months, including the $90 transfer fee, saving you nearly $181.
It's important to note that balance transfer cards typically require good or excellent credit. You should also be aware of the terms and potential fees associated with balance transfers, such as limits on the amount of debt you can transfer, the length of the intro 0% APR period, the timeframe for transferring your debt, and balance transfer fees, which typically range from 3% to 5% of the total transfer.
By utilizing a balance transfer card, you can take advantage of the promotional period to make payments directly toward your principal balance, helping you to pay off your credit card debt more efficiently and effectively.
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Debt consolidation is an option for student loans
When deciding whether to pay off credit card debt or student loans first, it is generally recommended to prioritize credit card debt due to its higher interest rates. However, juggling payments for both can be challenging, and debt consolidation is an option worth considering for student loans.
Debt consolidation allows you to combine multiple student loans into a single loan, simplifying your repayment process. This approach can offer several benefits. Firstly, it reduces the number of payments you need to manage, making it easier to stay on top of your finances. Secondly, consolidating your student loans may result in a lower average interest rate, which can lead to significant savings over time. It is important to note that you may not always get a lower interest rate with consolidation, but the weighted average of your previous loans' interest rates is rounded up to the nearest one-eighth of one percent.
Before pursuing debt consolidation, there are a few important factors to consider. Firstly, ensure that your credit score is strong enough for a lender to approve your consolidation application. Secondly, understand whether your consolidated loan will be considered a student loan or a personal loan, as this may impact your interest tax benefits. Additionally, be mindful of any service fees associated with refinancing your student loans and whether you will lose any discounts you previously had with your original loan originator.
It is also essential to distinguish between debt consolidation and refinancing. While debt consolidation combines multiple loans into one, refinancing is when another financial institution pays off your previous loans and provides you with a new loan at a lower interest rate. Refinancing can be an option for those with good or excellent credit scores, but it may result in losing payment flexibility and special benefits associated with individual lenders or government loans.
In conclusion, debt consolidation can be a viable strategy for managing student loan debt. It simplifies repayment, potentially lowers interest rates, and enables borrowers to pay off their student loans more quickly. However, careful consideration of the potential advantages and disadvantages is necessary before proceeding with any debt consolidation or refinancing decisions.
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Frequently asked questions
It is generally recommended to pay off credit card debt first due to higher interest rates.
The average credit card APR was 20.92% as of February 2023, whereas student loans tend to have lower interest rates, with federal loans being as low as 0% and private loans starting at 2.89%.
The general rule of thumb is to pay off the debt with the highest interest rate first. However, it is important to consider your personal financial situation and what motivates you.
You can transfer your credit card debt to a balance transfer card with a 0% introductory interest rate and pay it off during the promotional period. Another option is to refinance your credit card debt with a financial institution that offers a lower interest rate.
You can explore consolidating multiple student loans into one to simplify payoff, lower the average interest rate, and pay off your debt more quickly. Additionally, you can look into specialized repayment plans or student loan repayment assistance offered by some employers.
