Note that the student loan situation has changed due to the impact of the coronavirus outbreak and the relief efforts of the government, student loan lenders and others. This includes an automatic interest-free repayment break for all student loans held by the federal government. Check out our Student Loans Hero Coronavirus Information Center for news and additional details.
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Whether you’ve relied on credit cards to cover you between paychecks or taken out a personal loan in an emergency, debt can start to haunt your finances.
You may already be working on some creative solutions, such as using student loans to pay off your debt. And if you’re a student or recent graduate, the lower student loan interest rates are likely to be attractive compared to the higher APRs on credit cards and personal loans.
But even with the potential savings, this debt restructuring strategy may not always make sense. Here are four facts to unpack before you decide:
1. The merits of paying off debt with student loans depend on interest
2. Using student loans to pay off debt might not be smart
3. Paying off other debts could violate your loan agreement
4. There are alternatives to using student loans this way
Before Using Student Loans to Pay Off Debt, Consider Interest Rates
Using student loans to pay off a credit card or other high interest debt can seem like a good idea when it comes to saving on interest.
Federal student loan interest rates are generally designed to keep the college affordable and accessible. Currently, the fixed interest rate for direct undergraduate loans (subsidized and unsubsidized) is set at 2.75% for the 2020-21 school year. It is likely to be significantly lower than the interest rates that most students could claim on credit cards or personal loans.
A typical credit card interest rate is around 15.00% or more, but some evidence suggests that the average student credit card APR can be even higher. That’s more than five times the interest rates on federal student loans, which means those balances will grow five times faster than student loans.
Of course, if you have a higher student loan interest rate (depending on when you borrowed) or a lower credit card APR, the difference might be smaller.
Averages tell an important story, however. The average credit card balance for a student is $ 1,183, according to a 2019 report by Sallie Mae. With an APR of 17%, if you pay $ 100 per month for principal, you will earn $ 121 d interest in one year. If it were replaced with a 2020-2021 federal undergraduate rate student loan and you pay $ 100 for principal, the annual interest charge would be $ 18.
Despite the potential savings, using student loans to pay off debt may not be smart
While the numbers may sound compelling, there are reasons not to use student loans to pay off debt – that’s because there are key differences between credit cards, personal loans, and student debt. .
Federal student loans offer unique advantages. They offer options like income-driven repayment plans that can help keep payments affordable if your income is low. Interest paid on student debt is also tax deductible, saving you more money in the long run.
On the other hand, student loans have historically been more difficult to pay in bankruptcy than consumer debt. This means that student loans are more likely to follow you throughout your life, as turning consumer debt into student loan debt can make it harder for you to get out of debt if you have to go bankrupt as a last resort.
Plus, keeping a credit card or personal loan and working to pay it off might be a more effective way to build credit. Rather than mixing up debt, it may make more sense to focus on paying off consumer debt and then finding ways to pay off your student loan as well.
Low interest is always interest, and that interest will accumulate over time. While using student loans to pay off debt might seem like a smart short-term strategy, you still have to deal with a large balance that could become overwhelming very quickly.
Using Student Debt to Pay Off Other Debt Could Violate Your Loan Agreement
Additionally, there are legal guidelines on how student loans can be used. The Federal Student Aid Offices (FSA) claim that “all loan funds should be used for your education expenses.” You can spending student loans for tuition, board and lodging, transportation, and a personal computer.
This means that using student loans to pay off debt can technically fall under the category of student loan misuse. It is difficult for the Department of Education to track and enforce ‘abuse’, but if your loan originator finds out that this is how you used your loans, you could be in trouble for violating your agreement. loan and be subject to penalties, such as a fine or loss of your eligibility for future financial assistance.
Note that there might be gray areas if your debt was incurred while you were in college. Perhaps you’ve used student loans for living expenses that fall under the FSA’s definition of education expenses, such as school-related travel or a car used to get to class.
You could also be clear if you are using student loans to pay off credit card debt that has accrued for generally approved education expenses. If you’ve used the plastic in your wallet to buy a new laptop (so that it can mark the cash back bonus, for example), it makes more sense to use student loans to pay off credit card balances. .
Know that there are alternatives to using student loans for credit cards and other debt.
Paying off high-interest debt now, with cash, could save you more in the long run than just carrying it over to your student loan balance.
There are many ways to make this kind of progress without having to resort to student loans to pay off debt, including:
If you are able to pay off your debt, try to prepay your student loan debt after you graduate. Keeping your payments up-front will help you save on interest so you can work on debt-freeing completely.
In the meantime, figure out what got you in debt in the first place. A budget can help you stay on track and avoid these issues in the future. It may also be a good idea to develop a plan to create an emergency savings account to cover unforeseen expenses.
Even if you were on a tight budget as a student, having good financial habits can help you manage a salary and prevent debt from spiraling out of control in the future.
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