Dear Liz: I currently owe $27,000 in student loans at an 11.5% interest rate. I have excellent credit and about $8,000 in savings and contribute 17% of my income to a workplace retirement plan. Should I invest less in my 401(k) and pay off debt instead? I just got a balance transfer offer for 0% for 15 months with a 3% transaction fee. I’m considering taking $3,000 and putting it toward my high-interest student loan.
Answer: If you had federal student loans, transferring any part of your debt to a credit card would be a bad idea. That’s because federal student loans come with consumer protections that allow you to reduce or even eliminate your payments if you fall on hard economic times. You certainly wouldn’t want to reduce your retirement savings to pay off these flexible, fixed-rate loans.
The higher rate you are paying indicates that you have private student loans, which typically don’t have the same protections and which usually have variable rates that will climb higher when inflation returns.
Credit card debt has similar flaws — plus you would lose the interest rate deduction on any student loans you paid off this way. Instead, you may want to investigate the option of refinancing and consolidating your private student loans with a credit union. Credit unions are member-owned financial institutions that often offer better rates than traditional lenders. One site representing credit unions, CUStudentLoans.org, currently advertises variable rates on consolidation loans that range from just under 5% to just over 7%.
If you continued to make your current payments on a consolidated loan with a lower interest rate, you would be able to pay off your loans years faster — saving on interest without jeopardizing your future retirement.
Over the last few years, in the course of a house renovation, I bought a number of expensive appliances and electronic devices and took advantage of 0 percent offers from the vendors with no transaction fee if repaid within 18 or 24 months. I then programmed automatic payments on my bank account so that these amounts would be fully repaid within the timelines. The way they typically work is that a bank, working with the vendor, will issue a credit card with a maximum credit limit equal to the amount of the purchase.
I thought nothing of this until my credit report was ordered for a house refinance and I discovered that my score was negatively impacted because on the report these cards, particularly in the early months of the loan, show high balances in relation the credit limit on the card. This was true even though I pay the balance on my credit cards charging interest each month, as you have repeatedly advised.
Thanks for sharing your experience, Daniel. I hope the damage wasn’t too great.