Credit Card Debt vs Student Loans. When you owe money to multiple lenders how do you decide what to pay off first? (Spoiler alert: credit card debt is the winner) Wrangling debt is a huge factor when it comes to whipping your credit score into shape – but having multiple payments can make it difficult to prioritize which bill you should pay off first. If you’re trying to decide between aggressively paying off your credit card debt or your student loans, picking which payments to target requires big-picture thinking and a bit of credit know-how.
Credit Card Debt vs Student Loans
Lenders have historically viewed credit card balances as bad debt, which is debt that doesn’t increase your net worth. If you plan on applying for a major loan in the near future, you’ll definitely want to reduce your credit card debt to become more appealing to credit issuers. Displaying responsible repayment habits can also result in a better credit score in the long run. In direct contrast, student loans are traditionally considered to be good debt, since they’re an investment in your future which typically result in a higher income. These loans usually have lower interest rates and have longer payoff periods. It’s not uncommon to find school loans with repayment terms of 25 years or more. Banks and other lenders won’t be frightened of student loans on your record – so there’s no real rush to pay them off.
Why Prioritize Your Credit Card Debt?
Naturally, we’re huge advocates of always paying off your credit card debt (and keeping it down), but there’s a lot more to it than that.
Avoid Interest from High APRs
Credit cards are notorious for having unforgiving APRs. It’s not uncommon to see cards with interest rates over 25% – that’s one-fourth of your entire monthly balance in interest! One of the main reasons to pay off your credit card debt vs. student loans is simply that credit card APRs are usually higher than the interest rates of student loans. For example, say you owe $1000 on your credit card and in student loans. If your credit card has an APR of 25% but your student loans have an interest rate of 5%, you will end up being charged $250 in interest for your credit card compared to only $50 for your loans. Simply put: paying the bill with the highest interest rate will keep money in your pocket in the long run.
Improve Your Credit Score
Paying off your credit card can do wonderful things for your credit score: namely, by improving your credit utilization ratio. As the second most important factor that affects how credit scores are determined, improving this ration can lead to long term benefits for the health of your credit. Credit lenders like to see credit utilization percentages below 30%. You can help be either expanding your credit limit (opening a new credit card) or lowering your existing one; we prefer the latter since it poses no risk to your current credit score unlike the hard inquiry of applying for a credit card. Consistently paying off your credit card debt can lead to a credit limit increase – which is great for shopping and your credit score.
The Drawback of Focusing on Credit Card Debt
The cyclical nature of revolving credit can make the benefits of paying off your credit card balance short-lived. Running a large monthly balance every now again will raise your credit utilization, causing your credit score to drop just as quickly as it rose. While a constantly fluctuating credit score won’t cause long-term damage to your credit score, the act of paying off your credit card balance alone won’t provide long-term gains.
Student Loans are Actually Helping Your Credit Score
Believe it or not, but your student loans are actually a good thing. While they may not be included in the credit utilization ratio, each loan is a separate account that can contribute towards:
- The total number of your accounts
- The average age of your credit
- Improving your debt diversity
- Your payment history
Paying off your student loans prematurely would affect your debt diversity, lower the overall age of your credit history (if they were your oldest accounts), and reduce the total number of accounts in your credit history. If you want to use student loans to improve your credit score, instead of rushing to pay them off, focus on making on-time payments that are above the minimum amount due. Let your student loans run their course while you reap the credit benefits.