Debt can be crippling, painful, and downright scary to have. Everyday of the 29 months I worked to pay off my debt after college I felt like I had a huge weight on my shoulders. After I paid off my student and car loans I was so glad to be free! Now that I again have debt and share the responsibility of my wife’s student loans, they are an ever-present grey cloud above our heads.
That being said, we both know that it could be a lot worse.
We could have graduated college with much more debt. I could have accumulated student loans while getting my MBA instead of paying it off as I went. I could have delayed paying off my loans and lived a much more luxurious lifestyle for a few years. We could have racked up thousands of dollars in high interest credit card debt instead of staying frugal. We could have bought a house and be upside down in our mortgage. Our wedding could have put us deep in debt. The list goes on and on.
While we consider ourselves to be very fortunate that we have both been raised to be relatively frugal, I know there are others that struggle to make ends meet even when they are trying really hard to do so.
Help a Reader
I recently got a question from a friend and reader of Pocket Changed about taking out additional student loans to pay off some credit card debt. While at first I was a bit surprised at the approach (I would fear that credit card debt could easily just accumulate again), the more I thought about it, the more sense it started to make.
If her credit card debt is $5,000 and the interest rate is 16.9%, she is paying $70.83 in interest each month to start. It would take her 271 months (22.5 years!) of paying the minimum to pay it off and in that time she would pay $6,524.21 in interest.
If she instead takes out a student loan at 6% and slowly pays off the credit card amount, the interest would be reduced to $25.00 per month to start. It would then take 242 months of paying the minimum and $2,219.46 in additional interest to pay it off.
I know which option I would rather choose. With this tactic I have a few caveats though.
- I would highly recommend that the credit card not be used again until the amount you transferred into a loan is fully paid off. You have to turn off the debt faucet.
- Pay more than the minimums whenever possible. EVERY extra payment helps in the long term to reduce the amount of interest you would pay. Use a “true cost of paying the minimums” debt calculator to see the difference.
So, what would you do in this situation? Would you take out more loans at a lower interest rate to pay off a credit card balance?
(photo from Stuck in Customs)
{ 22 comments… read them below or add one }
The interest that she pays if it were a student loan could be tax deductible whereas the interest on the credit card is not, but I have a couple of problems with this:
1) Student loan debt is NEVER and can NEVER be forgiven. Should your friend be unable to pay, the debt will live on in forever while she could have charged off the credit card debt.
2) Student loans are supposed to be used for the costs associated with attending school isn’t it? Was this debt from school?
3) The odds are that your friend will run the credit card right back up again and be left with 2 debts
4) Had your friend explored other options such as a consolidation loan or a loan from a peer-to-peer lender?
Whatever your friend does, I wish them well.
Sandy
Thanks for the responses Sandy. You make a great point with #1 & #3 especially. I will pass your thoughts along.
Good post and good ideas. Loans are a good way to get rid of credit card debt, assuming the person has enough discipline to not use the cards. I would not absorb your credit card debt into your home, you end up paying way more due to the timeframe. I see it happen a lot working in the mortgage industry.
Great advice Sam. Keeping your mortgage separate is the best way.
Converting credit card debt to loans only works if there us a firm commitment not to use credit cards again (like closing accounts). Otherwise there is the tendency to fall back into the same pattern of overspending.
Thanks Tyler! I agree. Avoiding going into more CC debt is the key.
I agree with Sandy in the first comment. Having been through bankruptcy myself, I am thankful that I didn’t have any student loans at the time (they were repaid with military service). But my credit card debt? All gone.
No one expects to go through bankruptcy. Hell, it was the most gut wrenching time of my life. But if I still had student loans at the time. . . they’d still be with me.
On another note, and a bit of a tangent, when I was in law school the stock market was booming at the time and I knew more than one classmate who took out extra student loans and used it to invest. And they came out on top. A similar situation of playing one interest/return rate against the other.
Good point Vic! Although, no one really plans to go through bankruptcy.
Can she really only afford to pay the minimum? Even in the course of a couple of years her income should increase to the point where she can afford to pay more than that. (bringing total paymen time and interest waaayyyy down from 22 years!) All bonuses, freelance money, Christmas cash etc should go straight to the credit card.
I feel REALLY sketchy about a student loan being used for personal debt!
At this point yes, minimum payments only. In a couple years when she graduates she would increase payments.
I’m with many of the folks above. Using a student loan for things other then student expenses feels like fraud to me. I also think it is highly unlikely that she won’t go back to the credit card pool again. It is too easy. She should look for other consolidation options to see if she can get that rate down and she should, no matter what, vow not to use credit again until it is paid off.
I went through a rough time in my twenties where I was not in control of my spending so I froze all of my credit cards (in actual ice in the freezer) which kept them available for an emergency but not easily available to use. I switched to a debit card for carrying in my wallet and I haven’t looked back!
For what its worth, from follow-up email with the reader that asked me this, the costs on the card are directly related to living and school expenses. Nothing that would be considered extravagant costs that were not needed.
While I agree with the sentiment of sandy’s post, the fact is, student loan debt is forgivable and reducible. The federal government does it for federal workers, some military members, and teachers of certain federally mandated schools, and even civil service employees. If I were getting a degree in a field where I knew I could get a job and possibly have some of that debt forgiven I would jump all over the scenario. Most of those jobs, which you can view through federal websites even stipulate that as a perk of the job.
As a side note, Caleb, great post, I love how you break down the analysis into a total dollar amount and show the total interest paid over time, I don’t think enough people think of those ramifications.
Thanks Craig!
I would say it’s okay to do the student loan option, but I would literally cut up the credit card so it can’t be used. Otherwise, the temptation is there to spend again.
The only argument I would make for keeping it as credit card debt is that it would motivate here to pay down the debt faster.
Exactly Jeffrey. Cut up that card or freeze it in the freezer so you don’t use it again till it is paid off.
I’m a little late on replying to this, but if your friend takes out the student loan, I would recommend that even though it can be deferred while she is in school, she should continue to pay the amount. But if the student loan interest is 6%, she might also want to consider peer to peer lending as an option. Granted the student loan interest can be written off, but with a peer or consolidation solution, she could get it paid off in a much shorter timeframe than the 10 years that student loans are normally amortized over.
Thanks Shana for the idea. Having the timeline of the peer-to-peer loan would be shorter and could be a good option if the interest rate is lower.
I would always opt for the cash flow, especially when getting a better interest rate at the same time. Key like many others said is having the discipline to not use the credit cards any more. The only time I use credit cards is when I already have the cash to pay it off right away, or if I’m using it for short term purposes as leverage in my business to get a return that will be much greater then the interest rate I am paying to the CC company.
Going with the cashflow is best I think too Jason. Thanks for chiming in.
The key to eliminating credit card debt is to develop the self control to not use the card(s) until you get out from under that debt. I speak from years of painful lessons learned on this and paying off almost $25K in CC debt. One of the methods I used to significantly reduce the amount of interest I was paying was to transfer balances to cards with promotional interest rates. I picked offers that had no transfer fees and typically the interest was either 0% for a period of time or 1.9%. Yes, it means getting yet another credit card but that is where the self control part comes into play.
Matt,
It’s rough getting out of credit card debt, I’ve also been there and gotten out as well. Now while getting out of credit card debt, you also want to keep a good credit rating (if that’s also a goal) balance transfers can either hurt or hinder. The APR really doesn’t matter because what you’re effective interest rate is what matters.
It’s the same concept as a bi-weekly program for a mortgage, you make bi-weekly payments to your credit card thusly cutting down the per diem interest and cutting your effective interest rate. Things like this will cut down on interest and help you pay things off way faster. Hope this helps as well.