Should I pay off one debt with another?
October 27, 2009 12:54 PM   Subscribe

StudentLoanFilter: Should I use my student loan money to pay off my last credit card? long-ish explanation of my situation inside.

I'm going back to school in January (for a teaching cert after already receiving a bachelor's degree) and I've qualified for more loans than my tuition. I know I'll need some money to cover textbooks and other school supplies, but I'll still have about 5-6K left over (if I take it).

A little background: I had been working through a debt snowball when I was making about twice as much as I am now, and managed to pay off 4 of my 5 cards, leaving me with my highest balance card left. It's currently at a balance of ~5K at an interest rate of 19.99%. My minimum payment is around 150/mo.

I'm now netting about 14K a year working full time and this 150/mo is really starting to take a toll.

As far as other debt is concerned, I have 13K in federal subsidized loans locked in at a rate of about 4% from my bachelor's degree that I have a deferment for, which will be active until I'm done with my teaching certificate. I'll probably have between 33K and 38K in loans by the time I get my certificate (which should be doable based on the "don't take out more than you expect to make in the first year of work" advice). I also have an 8K auto loan at 7%, which is about 200/mo.

My financial aid award is for 5500 in federal subsidized loan at 5% and 6100 in federal unsubsidized loan at 6.8%. From what the financial aid office told me, as a returning student, I'll qualify for enough subsidized loans to pay for tuition each semester, so I will only be accepting this extra 6100 once and then I'll decline it each semester after this one.

Is this a stupid thing to do? Is it allowed? Does anyone care? The way I figure, I'm basically swapping a 5K balance at 20% for a 5K loan at 6.8%. I know I'll accrue interest in the next two years while I'm in school, but I'm guessing the extra $150 dollars I'll have each month will more than make up for it. (I might actually be able to save again!)

Any help or advice would be greatly appreciated.
posted by ThaBombShelterSmith to Work & Money (9 answers total)
Provided there are no transfer fees or other penalties (and read and re-read the fine print), and you can continue to make appropriate payments, you should always move your debt to the lower interest rate.
posted by Cool Papa Bell at 12:59 PM on October 27, 2009 [4 favorites]

Absolutely. The interest rate on the student loan is not only lower, but it's a whole lot less likely to be subject to arbitrary changes in the rate or other terms than the credit card will be. Credit card companies can pretty much change everything about your 'loan' at will and your only choices are to pay it off immediately or accept.
posted by Bokononist at 1:11 PM on October 27, 2009

Agreeing that you should do it for the reasons listed above. And bonus: student loan interest is tax deductible.
posted by something something at 1:24 PM on October 27, 2009

The above advice is only valid if you stop using the cards. I guess it's valid regardless, but if you keep using them you will be right back where you were.

If you are debt snowballing you need to make sure you don't just pay off the cards and suddenly have a much bigger student loan.

People all the time trade in credit card debt on a house refinance or second mortgage or some crap, then you're paying off the cheeseburger like a 30 year mortgage, because it is!
posted by cjorgensen at 1:53 PM on October 27, 2009

Yeah, I've already stopped using my cards, so I've already been paying off that cheeseburger for the past 6-7 years at a whopping 20% interest rate.

Thanks for the answers folks, this is a weight off my mind. I've been worried about this card for the past 4 or 5 years!
posted by ThaBombShelterSmith at 2:01 PM on October 27, 2009

There's a pretty strong psychological reason to pay off the card, too, in my experience. When I had $5000 on credit cards, an extra $5 (or $50, or $500) added to it didn't seem like a big deal. Now that I don't have a balance, I feel pretty strongly about keeping it that way, and actually spend less than when I was in debt. Silly, yes, but true.
posted by MrMoonPie at 2:49 PM on October 27, 2009 [1 favorite]

I am a financial aid professional. I also managed to get myself out from under some high interest rate debt by paying off a credit card with my student loan proceeds back in the day. It worked out wonderfully for me. While paying off credit card debt is not exactly a kosher use of your student loan funds, once the money is in your hands the financial aid office has no way of tracking what you do with it, nor would they be interested in doing so.

Since you are taking out an unsubsidized loan, though, I wanted to add a little bit about the way the interest accrual works on these kinds of loans.

You have 2 options, you can either pay the interest as you go or you can defer the interest payments until you graduate or your enrollment drops below 6 credit hours.

If you defer the interest payments the accrued interest is capitalized when your loans go into repayment. This means that the lender will take all of the accrued interest, tack it onto your original principal amount, and charge you interest on the new principal balance. Essentially, it's paying the interest twice on one loan. So, say you borrow $500 and accrue $50 in interest. When your loans go into repayment, your principal loan balance becomes $550 and you are paying 6.8% interest on that amount.

In the long run you are better off if you can manage to make your interest payments on your unsubsidized loans while you’re in school.

PS: Once you have your certification, ask your lender about the loans for service program. It could help you get a nice chunk of your student loan debt forgiven.

PPS: You should also check to see if you're eligible to receive any Pell Grant funds. Even though Pell Grants are not for people with BA's, at my school, those who are seeking their teaching certificate are the exception to that rule.
posted by omphale27 at 3:22 PM on October 27, 2009

Thanks for the advice omphale, I'll definitely see about the pell grants. I think because the school I am going to is primarily an education institution, they might not make an exception, but I'll certainly ask.
posted by ThaBombShelterSmith at 7:17 PM on October 27, 2009

Just want to mention that student loan debt is treated differently from consumer debt if you ever have to file bankruptcy.

It's probably not an issue in your case, but I wanted to mention it in case anyone else considering this has different circumstances, they should check it out before making the decision.
posted by CathyG at 7:19 AM on October 28, 2009

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