Frequently asked financial questions are questions that I’ve seen pop up over and over again. I thought I’d take the time to answer them in this Frequently Asked Financial Questions Series. So each post will have a short quick answer to these frequently asked financial questions followed by a longer more detailed answer.
Should I Pay Off Credit Card Debt or Student Loans First?
So long as you don’t default on either, it is probably best to pay off credit cards first. Why? Because credit cards are considered revolving debt. Meaning they can have a bigger negative impact on your credit score if you maintain a balance on them.
Although student loan debt is still debt, and you should want to eliminate it, it will most likely not affect your financial standing as harshly as credit card debt over time.
For example, student loan debt typically has a lower interest rate, can be tax deductible, and can actually help your credit score in certain circumstances. All of these factors play a part in why you should pay off credit card debt first.
So now you know which debt is the most important to pay off first, but WHY should you pay off credit card debt first?
How Debt Impacts Your Credit Score
Both your student loan debt and credit card debt will impact your credit score. However, the type of impact varies. Student loan debt, unlike credit card debt, is not considered revolving debt which means it doesn’t impact your credit utilization, one of the biggest factors in calculating your credit score.
Your credit card debt, on the other hand, is usually at the heart of your credit utilization. The higher your credit utilization, the lower your credit score. For example, if you have a credit line of $10,000 and currently have a balance of $6,000, your credit utilization is 60%.
You want to keep utilization below 30% and ideally below 10%. The more you utilize a card, and the less you pay on it, the riskier you look. Not only will this make it hard for you to approved for other loans in the future (should you need them), but it will also negatively impact your credit score. A lowered credit score can even impact you in unexpected ways, like getting a new phone or apartment, and possibly even a job.
Another big factor when calculating your credit score is your payment history. As long as you are paying the required monthly minimum for your student loans on time every month, your student loans help to provide a balanced credit mix.
So you shouldn’t skimp on your student loans just to pay off credit cards! If you have to pay minimums on student loan debt for a while to eliminate your credit card debt, that’s okay. It still gets reported as being paid on time, and your credit score should still improve.
Credit Cards Usually Have Higher Interest Rates
Even when you have large amounts of student loans, the interest rate is generally lower than it is on credit cards. But even a small credit card could cost you a small fortune in the long run. The average credit card boasts anywhere from a 14-20% interest rate, and that’s just a ballpark. There are many credit cards that have even higher interest rates.
Student loans, on the other hand, tend to top out around 9% and can be much lower depending on when you went to school. If you have private loans, you always have the option to refinance to save on interest or your monthly payment.
Wrapping it Up with a Bow on Top
At the end of the day, you should pay off whatever debt you can as fast as you can. However, due to the impact on your credit score and overall financial standing it is likely wisest to pay off your credit cards first so long as you are still able to keep up with your student loan payments. If you need help prioritizing all your debt and determining the best method (snowball, avalanche, nor’easter, and/or snowflake) for paying off your debt you can read my post on Prioritizing Your Debt.
Read more from the Frequently Asked Financial Questions Series.