Having tens of thousands of dollars in student loans can be intimidating enough for a new graduate. Add a few thousand dollars in credit card debt and the situation can feel downright complex.
If you have both student loans and credit card debt, you’re likely wondering:
Should you put the majority of your money toward paying off your credit card debt while meeting only the minimum payments on student loans? Is it the other way around? Or should you be making equal payments to both?
Should You Pay Off Credit Card Debt Or Student Loans
Below, you’ll learn how to manage both types of debt depending on the scenario you’re in. Please note these scenarios are not exact and are only meant to be guidelines.
Credit Cards First
When you’re being charged an outrageous rate on credit cards and minimum payments are barely making a dent, paying far more than the minimum payment can help get things under control.
Why? Because when you have a higher interest rate, your minimum payment may not be enough to pay down the principal.
Until the principal amount begins to decrease, your credit card debt will actually grow. This happens because your entire minimum payment is only going toward interest. For this reason, it’s important to pay more than the minimum amount due on your credit cards each month.
Unlike student loans, credit card interest rates can fluctuate, usually adjusting up. The more you can pay down a high-interest credit card, the less vulnerable you’ll be to an increase in your interest rate.
Most student loans are going to have single-digit interest rates while higher rate credit cards will at least be in the teens. Once your credit cards have been paid off, you’ll be able to apply those larger payments to your student loans, which will help to pay them down much faster.
Outstanding Balance Transfer
If the option is available, transferring some of your credit card debt to a 0 percent APR promotional can reduce the amount you’ll pay in interest. As an example, let’s say you have a $7,000 credit card balance at 15 percent interest. There’s also a $5,000, 0 percent APR, 12 months, 3 percent transfer fee promo available.
Here’s what the numbers look like:
- Total interest on $7,000 paying $150/month for 12 months at 15 percent: $996.23 in interest.
- Transfer $5,000 for 12 months with a 3 percent fee: $150.
- That’s an $846.23 difference in interest.
Of course, you’ll still have to continue paying the remaining $2,000 at 15 percent. Over 12 months, that’s $192.45 in interest, which is a total of $342.45. That’s still an overall difference of $653.78 in savings.
Additionally, the balance will have come down from $2,000 to ~$1,100, assuming ~$75 of the $150/month payment goes toward the principal. The results of both scenarios are still a balance of $6,100.
If that is the case, what was the benefit of using a balance transfer? The savings of $653.78 in interest.
If you spread that out over 12 months, that’s $54.48/month. If possible, upping payments from $150 to $200 will result in a balance of ~$800 on the original $2,000 balance. Now the total balance after 12 months is $5,800 instead of $6,100.
Paying Higher Interest Rates Aren’t Always the Best Option
There’s also something to be said about paying off smaller balances, even if they are a lower rate. There’s a psychological benefit to paying off a loan. It can provide some much-needed momentum to keep with a plan of paying down loans. However, this article is focusing purely on financial advantages.
There is another strategy that can overrule paying higher interest rates first. That’s when a loan or credit card requires a high minimum payment. This will often be reflected in credit cards rather than student loans.
Credit card minimum payments usually range between 2 percent and 3 percent.
- On a $7,000 balance, that’s $140 to $210 minimum payment per month.
- If a credit card is requiring a 5 percent payment, that’s $350/month.
This can significantly crunch cash flow. Paying more to this credit card can provide a big benefit since once it is paid off, it will free up lots of cash flow for higher rate cards.
Paying More to Student Loans
This scenario can work when the interest rates on any credit cards are comparable or less than that of your student loans. The over-arching theme is that paying more on higher interest rates saves more in the long run.
Student loans are likely to be far larger debts than credit card debt. By paying more to a higher rate student loan, you’ll extend the number of your credit card payments. But even then, if you can pay above the minimum payment on credit cards, it will decrease their balances much faster than just paying the minimum payment.
You’re likely to have only one or two student loans that have higher interest rates than any credit card. Once the higher rate student loans are paid off, freeing up cash flow can go to the highest rate credit card.
You can also look at potentially refinancing your student loans to get a lower interest rate.
Final Thoughts
Deciding to pay down student loans or credit cards first isn’t a complex decision. But knowing what is involved in making that decision can help you get the most out of your cash flow.
There is no right answer for everyone. Each situation is different. Hopefully, this article gave you some insights into which strategy might be best for you.