Student Loans vs. Credit Cards: Which to Pay Off First?
According to the latest data, more than 44 million Americans have student loan debt, with a total amount of $1.48 trillion. This is more than any other type of debt -- other than mortgages -- and translates to an average of $33,484 per borrower. For comparison, Americans owe just over $1 trillion on credit cards.
Here is a common question I'm asked: "Should I pay my student loan debts down as fast as I can?" And the surprising answer is generally no, especially if you have credit card debt as well.
While student loan debt is certainly a problem in the United States, and the epidemic of ever-increasing amounts of debt being taken on by college students needs to be addressed, credit card debt can be far more dangerous.
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Here's why student loan debt isn't nearly as much of a crisis as credit card debt
First of all, in the interest of full disclosure, I have more student loan debt than most. In fact, between undergrad and grad school, my student loan debt is nearly double the national average. So, if you feel like your student loan debt is a massive sum that seems like you'll never be able to fully pay it off, believe me -- I understand.
However, student loan debt is a much better form of debt to carry than credit cards. There's a reason I haven't been in too much of a rush to pay down my student loans. I'd even go so far to say that student loan debt is possibly the best type of debt, certainly better than most auto loans and even better than mortgage debt in many ways. Here's why I say this:
Student loan interest rates are dramatically lower than credit card interest. No direct subsidized or unsubsidized student loan made after 2006 has had an interest rate higher than 6.8%, and many are significantly lower than that. Even PLUS loans (made to parents and graduate students) haven't had interest rates exceeding 8.5%. Meanwhile, the average credit card interest rate is over 16%. To put this into perspective, on $1 trillion in credit card debt, Americans are paying roughly $162 billion per year in interest alone, and this is likely to increase if the Federal Reserve continues to raise interest rates. Meanwhile, based on an approximate average interest rate of 6.5% (my own calculation), student loan interest totals about $96 billion per year.
Student loan debt is fairly easy to defer. If you're going through tough financial times, such as unemployment or other financial hardship, you can apply for a deferment or forbearance, which can suspend your payment obligation (but not your interest) for a year or more. While credit card companies may work with you if you're having a tough time paying, they aren't likely to be nearly as flexible.
Student loan repayment is flexible. No other type of debt has as many repayment options as student loan debt, specifically the availability of income-based repayment. The Pay As You Earn repayment plan, for example, limits your monthly student loan payment to no more than 10% of your discretionary income.
Student loan debt can be eventually forgiven. While student loan debt generally cannot be discharged in bankruptcy, it does have several debt forgiveness programs. Teachers can qualify for as much as $17,500 in loan forgiveness after five years in the classroom, and public service employees can have any amount forgiven after 10 years of employment. And under the aforementioned Pay As You Earn plan, any remaining balance is forgiven after 20 years of payments (25 if you have graduate school debt).
Student loan debt can come with increased earnings power, if you complete your degree. I often tell people that a good debt is one that results from acquiring an asset that holds its value over time. And the increased earnings power of a college degree certainly qualifies. Think of it this way. Student loan interest rates are comparable to those charged on auto loans, but your car is a depreciating asset. Meanwhile, the increased earnings power of a college degree has permanent value.
Student loan interest is tax-deductible. Mortgage interest is as well, but only if you itemize deductions. The student loan interest deduction is an "above-the-line" deduction, meaning that it's available whether you itemize or not.
The bottom line: Pay your credit cards off as fast as possible
This statement applies even if your credit card debt is relatively low and you feel like you're "drowning" in student loan debt. It doesn't make any sense to pay more than you're required to on student loans, mortgages, or auto loans if you are carrying high-interest credit card debt.
To be perfectly clear, I'm not saying that student loan debt isn't turning into a crisis in the United States. It's certainly heading in that direction. Instead, my point is that I'm far more worried about the $1 trillion in credit card debt Americans have accumulated than I am about $1.48 trillion in student loan debt.
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