Paying off your student loans early is a worthy goal. But if you also have credit card debt, you may be wondering which debt to attack first. In most cases, it’s best to work on paying off your credit card debt before you add extra payments to your student loans. Here’s why that is and how to choose the right priority for you.
Why It’s Best to Pay Off Credit Cards Before Student Loans
Regardless of how much money you have left on your student loan balance, paying off your credit cards before you start accelerating your student loan payments is usually the best bet.
Credit Cards Are Expensive
The average interest rate on credit cards that assess interest is 16.97%, according to Federal Reserve data for the third quarter of 2019. In contrast, federal loan interest rates for the 2019-2020 school year max out at 7.079%.
Private student loans may carry higher interest rates than federal loans, but you’ll likely still pay more interest on a credit card than a private student loan.
For example, let’s say you have $10,000 in student loans with a 6% average interest rate, a 10-year repayment term, and a $111 monthly payment. If you don’t add any extra payments, you’ll be debt-free in 10 years and pay $3,322 in interest.
If you also had $10,000 in credit card debt, paying it off over 10 years would require monthly payments of $174, and you’d pay $10,856 in interest over that time.
Credit Cards Make It Easier to Be Complacent
Student loans have a set repayment term, which means that as long as you make your monthly payment every month, there’s a light at the end of the tunnel.
On the flip side, credit cards offer a revolving line of credit with no set repayment term. Your account has a minimum monthly payment, but it’s calculated as just a small fraction of your balance. If you’re not careful, you could end up paying a high interest rate for years to come. In some cases, you may never pay it off.
For example, using the scenario above, if you were to pay $111 per month on your credit card balance instead of $174, you’d never actually repay the debt because the payment isn’t even enough to pay the monthly interest charge.
High Credit Card Balances Can Hurt Your Credit
Your payment history is the most important factor in your FICO credit score. But second to that is how much you owe. While this element includes your total debt, it’s mostly influenced by your credit utilization rate. This ratio is calculated by dividing each credit card balance by its credit limit, as well as the sum of all your credit card balances by the total available credit.
For example, if you have a $6,000 balance on a card with a credit limit of $8,000, your utilization rate is 75%. Credit experts generally recommend keeping the ratio below 30%, and the lower it is, the better. If yours is much higher than that threshold, it could be damaging your credit score.
Does It Ever Make Sense to Pay Student Loans First?
If you can afford to make your monthly student loan payments and minimum credit card payment and put extra cash toward one or the other, it virtually always makes sense to pay down your credit card balances first.
If, however, you’re struggling to pay the minimum amount due on both, it may be better to focus on your student loans to avoid default. If it gets to that point, however, keep in mind that federal loans allow you to get on an income-driven repayment plan, which can make your monthly payment more affordable.
Also, the U.S. Department of Education and many private lenders provide deferment and forbearance options if you’re experiencing financial hardship. Credit card issuers don’t provide any of these benefits, but they may be willing to work with you on a modified repayment plan if you’re struggling.
If you have both student loans and credit card balances, consider your financial situation, the cost of each debt and other important factors to determine which is the best path forward for you.
If you’re struggling with student loan debt, consider if refinancing your loans is the right move for you. It could potentially lower your interest rate and reduce your monthly payment.
Keep in mind refinancing federal student loans means a loss in many benefits – income-driven repayment plans, any federal forgiveness programs, generous deferment options, and more.