Paying Student Loans with Credit Card
Many parents and students are often confronted with the prospect of paying student loans with a credit card. After all, if there ever was a “good reason” to finance something with credit card debt…isn’t an education the best one?
There are some factors you must consider with respect to paying off student loan debt with a credit card. These factors are the actual interest rates on the loans and the credit card, the monthly payment amount, tax consequences, impact on credit profile and credit rating, where you are at in the repayment timeline, and your current financial condition.
Interest Rates on the Student Loan vs. Credit Card
It makes very little sense to pay off a student loan with a credit card if the interest you are going to be charged by your credit card company exceeds that of your student loan provider. However, there are a couple of scenarios where using a credit card with a higher rate might make more sense. If you are in a tough financial situation and might be looking down the road at a potential bankruptcy, it would make strategic sense to pay off your student loans with credit cards so as to transition the debt out of the student loan category (which isn’t dischargeable) and into the revolving credit category. It might even make strategic sense to have a parent who is looking to potentially declare bankruptcy to pay off their student’s school loan debt on the same premise.
Please note that I am not an attorney and have never filed for bankruptcy. I would assume there are reviews of where money is spent by those seeking bankruptcy in the months before they filed bankruptcy. Please consult with a professional in this area as there is the potential for some liability if one is not careful.
Let’s get back to the subject of using a credit card to pay a student loan. The most likely and best way to use a credit card to pay a student loan is through the use of balance transfer checks. Credit card companies send checks in the mail to their cardholders and tempt them to use their balance transfer checks usually with offers of 0% interest loans. Generally, they will give cardholders an interest free loan for about a year. After the promotional period expires, the interest rate will increase to whatever the normal interest rate is for that card. It could be 9.99% all the way up to nearly 30%. It all depends.
More often than not, the card companies will also tack on a 3% transaction fee.
What does this all mean?
Well, right up front… you have to understand that the 3% transaction fee comes off the top. That means, if you pay down $10,000 worth of student loans with the offer you will show a balance of $10,300 on the next statement. Therefore, it is safe to say that your 0% balance transfer offer just shot up to 3% immediately.
Important tip: If you have a $10,000 limit on your credit card…do not use the full amount. Once they tack on that $300 fee your card will now be over the credit limit for the card and they will penalize you with a fee. The max you would be able to transfer in this instance would be roughly $9,700.
Once the promotion period ends, your interest rate will rise to a number that is probably higher than your current student loan interest rate. Therefore, you are going to want to limit your credit card usage t o instances where you are confident that you can roll the amount you placed on your credit card over to another credit card with a 0% balance transfer offer. Another scenario that may make sense is if you are expecting to come into a lump sum payment at a later date. This could be a work bonus, an inheritance, etc.
The truth of the matter is that you are rarely going to want to use a credit card to pay student loans.
With that said, it may surprise you to know that I actually have used credit cards to pay for student loans before. In the mid-2000’s, credit card companies were giving out 0% balance transfers without any transaction fees or they capped the fee to a certain dollar amount. I effectively transferred tens of thousands of dollars at minimal cost. However, the conditions that existed then were far more borrow friendly than the ones we have today.
Monthly Payment Amounts
Another important factor that one must consider when assessing whether or not they should use a credit card for student loans is the monthly payment amount. Credit cards will generally ask you to pay a monthly payment that is equal to 1 to 4% of your outstanding balance.
For example, if you owe $20,000 on your credit card the monthly payment could be $200, $400, $600 or $800. Even if the credit card company is charging you 0% interest a year on the money you borrowed, you may be financially unable to meet their monthly minimum payment amount. It is very important that you call your credit card company and ask them how they calculate their monthly minimum payment.
The interest you pay on your student loans is deductible on your taxes. If you decide to use a credit card to transfer your student loan balance you will lose some tax benefits because interest paid on credit cards is not tax deductible.
If you are going to be looking to finance a car or home purchase sometime in the near future, you do not want to transfer student loan debt to a credit card. Credit scores are impacted by the amount of revolving debt you have on your credit card. The more credit card debt you have, even if you are paying on time, the more likely it will have a negative impact on your score. Additionally, when you max out a credit card your score takes a hit because creditors like to see low debt to credit limit ratios.
If you have been out of school for a long time and have made many years worth payments, you are most likely going to want to avoid using your credit card. The reason being that when you pay interest on any loan, the bulk of the early payments are interest with very little going to principal.
Tip: Take the number of payments remaining on the loan and multiply that by the payment amount. Subtract the remaining balance on your loans from this number and that is the total interest in actual dollars you owe over the remaining term of the loan. That essentially becomes the effective interest rate for the remainder of your loan term.
Current Financial Condition
If you feel like you are on the brink of entering a downward spiral financially, it may make strategic sense to transition student loan obligations into the revolving debt category so that you can eventually discharge them during bankruptcy. Obviously, this is a delicate issue and one that you should investigate and research thoroughly before embarking on any course of action.
As you can see, the question of whether or not one should use a credit card to pay student debt obligations isn’t cut and dried. There will be instances in which it may make sense to do so. But, ultimately one will be better served by minimizing the use of credit cards unless they are extremely disciplined.
If you are interested in learning more about fantastic and rewarding careers that do not require a traditional four-year college degree, please visit the Ditch College career portal.