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To Pay Off Credit Cards or Student Loans First?

2 money symbolsAlmost everyone in the US is in debt.

The most common kinds of debt in the country currently are credit card debt and student loans.

This scenario begs the question – does one pay off their student loan or credit card debt?

It’s a catch-22 like situation, and to find an answer to this, understanding a few basics are in order.

First things first, both credit card debt and student loan are debts which means that sooner or later both these financial obligations have to be met and the debts need to be cleared.

We will discuss a few parameters here to help you prioritize between these two debts.

What is a student loan?

A loan taken to pay for a student’s post-secondary education and other associated expenses such as tuition fees, books and living expenses etc. is known as a student loan.

What type of debt is a student loan?

A student loan is said to be a good debt. An investment that grows in value and generates long-term income is known as a good debt. A student loan is an investment in the student’s career which grows in value as the student gains knowledge. And the long term income looks promising through the stable and well-paying job that the student is likely to get.

As much as the student loan being a good debt seems positive, the flip side is that there is no such thing as a guaranteed return on this investment. One takes a student loan believing that in a few years the loan would be paid of through a great degree and the consequent high paying job. The lack of assurance that there would be a great job at the end is something worth considering, though.

What are credit card debts?

The unsecured consumer debt that gets accumulated as and when someone buys goods or services through a credit card is called a credit card debt.

What type of debts are credit card debts?

Credit card debts are debts that do not generate income or add to your value, therefore they are referred to as Bad Debts. The interest rates on credit cards are sky- high and the payment or non-payment of these debts have a direct bearing on your credit score. Though credit card debts do not involve an investment which gives returns, it is an essential part of survival, getting accumulated through day to day transactions.

How does one compare student loan debt vs credit card debt?

While student loans give the much needed backbone to students to stand educated and independent, credit card debts help them go about their daily lives.

The principal amount of Student loans is huge whereas for credit card debts the interest piles up in no time.

Here is a compilation of average amount of student loan and average revolving credit card loan in five states of the United States of America. The following table will give you a fair idea of how the burden of student loan differs from that of a credit card debt.

State Average revolving credit card debt Average student loan debt
Alaska $5081.34 $28,570
Delaware $3919.01 $32,571
California $3766.33 $20,340
New York $3805.83 $26,381
Pennsylvania $3766.13 $32,528

As you can see in the above table, the amount of student loan is huge. The good part is that the interest percentage on most student loans is less than 10%. The loan cannot be written off on the declaration of bankruptcy which means that you are liable to pay it off through your lifetime. Although Student loans can be reduced or forgiven. Another Advantage of a student loan is that you do not need a credit score to avail one.

Though on the face of it, the credit card loan seems to be manageable, the interest rates are very high and the loan keeps piling up into staggering amounts. This is a loan that can be written off on the declaration of bankruptcy. The payments made against credit card bills and loans have a direct correlation with your credit score. Regular payments made before the due date raise your credit score.

What is a Personal Debt?

Personal debts are debts taken by individuals for consumption rather than investment. It also means that the loan is personal in not being for business. Personal loans are the ones which can be availed to meet any of your personal needs, it need not be specifically for a particular need. The rates of interest are usually higher than that of a car loan or a mortgage.

The reason is that personal loans, more often than not, are unsecured loans that means there is no collateral security offered by you for the loan. In case of a car loan the car is the collateral, in case of mortgage the house can be repossessed in case of a default. So, to secure their payments, the lenders charge a high rate of interest on personal loans.

How does one compare credit card debt vs personal loan?

Credit card and personal loan, both are means of borrowing money in times of need. The major difference between both is the suitability according to the time frame required to pay off your debt.

Credit card loans are extremely high on interest but the best part is that they are available at no interest or 0% interest for the first 30 days. That makes them the best choice to consider if you are reasonably sure of paying off the whole amount due within 30 days.

The worst way to use a credit card is to keep paying only the minimum due amount and let the insurmountable interest pile up.

Personal loans on the other hand, have lesser interest rates than credit card loans, but there is no cushion of an interest free period of 30 days. Personal loans are a better choice for medium to long term borrowings. For instance, if you are looking at a 2 to 5-year duration for paying off your loan, personal loans make sense.Whereas a credit card loan is much better if our pay-back period is 6 months or less.

Both credit card loans and personal loans have similar processing fee and pre-closure charges.

What is the impact that credit card debts have had on college students?

There are a lot of college student credit card debt stories that have gone the wrong way. What should have been a means to a bright and prosperous future has often lead to a lifetime of debt. So what is the way out? What are the alternates that a student can explore? Let us try and answer these questions for you.

What are the types of student loan help available in The United States of America?

There are mainly two types of student loans available:

  1. Federal student loans – loans funded by the federal government are called federal student loans.
  1. Private student loans – loans through lenders like banks, credit unions, state agencies or schools are called private student loans.

How do federal loans differ from private loans?

Here is a quick comparison between the federal student loans and private student loans:

Criteria Federal Student loans Private Student loans
Repayment starts After leaving school or after graduation While you are still in school
Interest rates Fixed rate and lower than private loan rates May be variable interest rates also
Subsidized loan option Available Not Available
Credit Check Not required Mostly required
Consolidation of loan under direct Consolidation Loan Allowed Not Allowed
Deferment of loan Possible Generally, not possible
Loan forgiveness Possible Generally, not possible

On the whole, Federal loans are more student friendly as the government’s motive is to promote education. The government encourages students through different avenues to take responsibility of their education without intimidating them.

The ideal way to go about it is to try to get federal loans to the maximum extent possible and then explore private student loan options. Private student loans may require a co-signer to assure the repayment of loan in case the student defaults.

What are the financial assistance programs made available in the form of federal student loans?

The different types of federal student loans are:

  1. Direct subsidized Loans

These are also popularly known as Stafford loans or direct Stafford loans. Direct subsidized loans are most suited for undergraduate students with financial need. The amount that can be borrowed is decided by the student’s school and does not exceed the student’s financial need. The most unique feature of this type of loan is that the U.S Department of Education pays the interest on direct subsidized loan:

2 man head like cashWhile the student is in school for at least half-time

  1. During the grace period of 6 months after the student leaves school.
  2. During the loan deferment period.
  3. Direct Unsubsidized loans

These are loans which are made available to both graduate and undergraduate students. For Direct unsubsidized loans there is no need to prove a student’s financial need. Depending on the student’s cost of attendance and other financial aids, the amount of loan is determined by the school.

The interest on loan is payable by the student at all periods. If the student is unable to pay while in school or during grace period or forbearance, the interest gets added to the principal amount of the loan.

  1. Direct Plus loans – for graduate students or professional students or parents

Direct Plus loans are federal student loans where the lender is the U.S Department of Education. To be eligible for this loan, one must be a graduate or a professional student or a parent of a dependent undergraduate student. Apart from this they are required to not have an adverse credit record. The amount of loan is determined by the school based on the cost of attendance and other financial aids.

  1. Federal Perkins loans

Federal Perkins Loan is a federal student loan made available to undergraduate, graduate or professional students with exceptional financial need. This is a loan where the lender is the school. The rate of interest is 5%. Only some schools participate in the Federal Perkins loan program. The amount of loan depends on the financial need of the student and the funds available with the school.

Apart from these, the federal government provides the student an option of consolidating all the federal loans availed, for free.

What are the different sources of Student loans?

If we have to make a chronological, exhaustive list of the different sources of finance for a student to fund his or her studies plus living, it would be as follows:

  • Federal student loans- As much as possible.
  • Private Student loans- to make up for the deficit, after considering all the federal loans. These are naturally not the first and most preferred option for the reasons discussed above.
  • Credit cards – For the day to day living expenses. The credit card bills should be ideally paid off with the monthly savings or part time earnings if any. This is advisable because monthly miscellaneous expenses should not amount to much and the aim should be to pay it off in the interest free period of 30 days. Strictly speaking, the credit cards should not be used to borrow for big and long term expenses
  • Personal Loans – These should be explored as a last resort for the long term expenses which could not be covered through the student loans.

Whether to pay off credit cards or student loans first?

Considering all the information provided above, the best conclusion to draw would be that it is best to be current on both credit card debts and student loans. Paying off a single debt and completely overlooking the other is not going to help in any way. That would just lead to one of the debts piling up. Both credit card debt and student loan are quite intimidating, with either the principal or the interest increasing the burden substantially.

If the outstanding amount on credit cards is more, it makes good financial sense to make as much extra payment towards it as possible. Subsequent minimum due amounts payable towards student loans would ensure less financial burden in future. Instead of choosing between both mandatory financial obligations, it is best to strike a balance between them through disciplined management of finance.

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