Paying For Education: Credit Cards or Student Loan?

Source:  Jeremy Jenum via Flickr

Source: Jeremy Jenum via Flickr

If you needed money to pay for your education, would you apply for a student loan or pay for your education with your credit card? Yes, I hear you, that’s an easy question; you would apply for a student loan. Of course you’d apply for a loan. After all, the interest rates charged on student loans are much lower than the interest rates that credit cards charge. Everybody knows this. Well, apparently everyone doesn’t know this.

I was sitting in my doctor’s waiting room yesterday. I wasn’t eavesdropping, but I couldn’t help but hear a conversation between a fellow patient and one of the doctor’s employees; we’ll call her Gretchen. Gretchen has decided to go back to school. Good for her! She’s taking classes in the evening while she’s working at the doctor’s office during the day.

While I don’t know what Gretchen is going to school for, I am going to assume that she is taking classes to better herself, both professionally and personally. As I said, I wasn’t really listening so I can’t tell you why the topic came up, but the patient asked Gretchen how she was paying for her classes. To my surprise and dismay, Gretchen indicated that she didn’t apply for a student loan because she didn’t want to have a loan hanging over her head. She said that she’d just rather use her credit cards to pay for her education.

Now I know that I am just making an assumption here, but I am presuming that Gretchen is not going to pay off her credit cards in full. I am suspecting that Gretchen will only be making partial payments on her credit bill and will carry a balance. As such, of course, she will be paying interest on her outstanding balance. The interest that she’ll pay on her outstanding balance will be higher than the interest than she would have paid if she had gotten a student loan instead.

Maybe I’m wrong about Gretchen. Maybe she’s shrewd financially. Perhaps she has a cashback credit card as is paying for her student loan on credit card to pick up some extra cash (cashback credit cards usually pay you 1-2% on all purchases), and paying off her balance in full with cash she has saved for this purpose. This probably isn’t the case however. Based upon the snippet of conversation I overheard, I am assuming that Gretchen isn’t terribly financially literate and her decision to pay for her education with her credit card was not arrived at by doing a cost analysis of any kind, but rather a matter of convenience.

Paying for your education with a credit card instead of securing a student loan will almost certainly result in higher interest charges, potentially much higher. Today, the average interest rate on credit cards is roughly 15%. That’s just the average; those people who have a poor credit score are likely paying substantially higher interest rates. People with bad credit may be paying as much as 23%.

Let’s assume that Gretchen’s education classes for this term are costing her $5,000 and that she paid for tuition with her credit card. Assuming that she’s paying that average, 15% interest rate, and that she’s only paying $100 each month on her credit card bill, it would take 79 months to completely pay off her student loan expenses, just for this term. Along with the $5,000 that she borrowed, she would pay nearly $2,900 in interest.

These are just her tuition expenses for this term. If she happens to be in a degree program, she’ll likely be in school for many years, especially if she continues to work full time. Each time she takes classes, and pays for them with her credit card, she will increase her outstanding balance and the time it will take for her to pay off her credit card balance. Further, if she continues to make the same $100 monthly payments, the cumulative expense and time to pay off the credit card debt will increase dramatically.

No Free Ride

Don’t get me wrong here; student loans providers are not offering interest-free loans either. However, the interest charges on student loans are typically much lower than the interest rates charged by credit card providers. Also, some student loans do not require you to start making payments on the loan immediately. Some student loan providers offer a waiting period where you can either pay a lower amount each month while you are attending school or they may allow you to completely defer any payments until after you have completed your education or if you stop going to school.

There are many different types of student loans: there are federal government student loans, private student loans, and student loans for those people who are taking classes in non-degree programs. Most students looking for student loans will get a combination of loans, partially federal and partially private. Federal loans are great, but typically they don’t cover everything. Private student loans can fill in the gaps as they may be able to cover all of your expenses, including tuition, books, fees, supplies, housing, meal plans, and even transportation. Typically, the interest rates charged for private student loans will be higher than government-backed loans.

Student Loan Options

Today, the interest rates charged on these loans may be as low as 4.66% for federal student aid. Private lenders charge more. As an example, Discover Card offers student loans. Yes, Discover, the credit card company, offers student loans for degreed and non-degreed programs. Presently, the interest rates that Discover is charging for student loans is below 6% for fixed rate loans and an incredibly low 2.99% variable rate loan. The variable rate loan is 3-month LIBOR +2.62%. (This rate adjusts quarterly based on the 3-month LIBOR rate as reported in the Wall St. Journal. LIBOR is the interest rate that banks charge one another. In today’s extremely low interest rate environment, the three-month LIBOR rate is priced incredibly low at just 0.29%. That’s about one-quarter of one percent.)

Discover Student loanNow I’m not going to suggest that Gretchen borrow money on a variable rate interest loan; even one with an interest rate of just 2.99%. Loans at too-good-to-be-true interest rates were instrumental in the housing crisis in 2008. People bit off more than they could chew and when the rates adjusted higher, they could no longer afford their homes and many were foreclosed upon. I would suggest a loan with a reasonable interest rate that is fixed, like the 6% fixed-rate student loan that Discover is offering. Discover even offers an incentive to get good grades; they will give you 1% cash back if your GPA is 3.0 or higher.

Discover Student loan chart

The terms being offered by Discover for a student loan are not available to everyone. These private student loans being offered by Discover are for undergraduate students who are in 4-year degree programs. Gretchen might not qualify; she might be taking a few stand-alone classes which are not part of a degree program or she might be taking classes towards a certificate which also wouldn’t meet the loan requirements.

 

sallie-mae_logo

If Gretchen didn’t attend an accredited school, her education might not qualify for either a Federal loan or a private student loan from Discover. But there are other options. For one, there’s Sallie Mae. Sallie Mae, originally known as the Student Loan Marketing Association, provides financial products to help families save, plan, and pay for college. They offer loans for both students enrolled in degree programs as well as those and attending college in non-degree programs. Sallie Mae offers both fixed rate and variable rate loans as well. The current interest rates for student loans from Sallie Mae are between 4.50% and 11.64%. The fixed rate loans are at the higher end; variables at the lower end.

Discover and Sallie Mae are just two potential lenders. There are countless other lenders offering student loans. Unlike federal student loans, a key criterion for qualifying for a private student loan is your credit score. If you don’t know yours, now is the time to check your credit score. As with all loans, the higher your credit score, the better your loan options will be.

Those who have poor or non-existent credit may have a very tough time getting approved for a private student loan. It would be easier to secure a loan if have a co-signer who has a good credit score. The co-signer could be your parent, any other family member, or anyone really. Even if you think you can qualify on your own for a student loan, having a co-signer can really save you money as the interest rate or fees (if any) will likely be lower. Of course, the co-signer will need to really trust and believe in you. Missing a payment or making a late payment will not only impact your credit score, but it will also negatively impact your co-signer’s credit score too.

Student Loan Delinquencies

Student loan delinquencies and defaults are on the rise. The numbers are staggering. There are 40 million outstanding student loans. The average balance on student loans is $29,000. The total outstanding balance is $1.2 trillion. Nearly 14% of those loans are in default. That number could continue to increase as graduates find it hard to get jobs out of school. If students can’t find work, it stands to reason they won’t be able to repay their loans.

I am happy to hear that Gretchen is going to school, but I am unhappy to hear that Gretchen elected to pay for her education with her credit card. If she had done a bit more research, she probably could have found student loans with lower interest rates than those she will be paying on her credit card. With any luck, while she’s in school, Gretchen will learn that amassing credit card debt is not something that she should aspire to.

Resources:

If you are in the market for a student loan, here are a few sources which you might find helpful:

Federal Aid:

https://fafsa.ed.gov/

http://www.direct.ed.gov/

Private Loans:

SallieMae: https://www.salliemae.com/student-loans/smart-option-student-loan/

eStudent Loan: https://www.estudentloan.com/

Wells Fargo: https://www.wellsfargo.com/student/

Discover: https://www.discover.com/student-loans/

If you would like to calculate how much your credit card purchases will actually cost you, including interest charges, and how long it will take to you pay off your credit card debt: http://www.consumercredit.com/financial-education/financial-calculators/credit-card-interest-calculator.aspx

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