Millions of Americans struggle to make payments on both student loans and credit cards. Workers in their early career and lower-income years are especially likely to feel the pinch. In the fourth quarter of 2020, Americans between ages 25 and 34 carried average student loan debt of $33,818, according to the U.S. Department of Education. Meanwhile, 47.6% of Americans under 35 carry credit card debt from month to month, and the average balance for people in this age group is $3,660.
If you're among those juggling student loans and credit cards, should you prioritize paying off one type of debt over the other? And, if so, which type of debt should you focus on erasing first?
How to prioritize
Paying off credit card debt should generally take precedence over paying off student loans. This is especially true now because President Biden extended the CARES Act provision for federal student loan forbearance, which allows borrowers to temporarily stop making loan payments. Under President Biden's executive order, payments on federal student loans can be deferred through September 30, 2021. Interest will not accrue while payments are suspended. To find out whether any of your student loans qualify for this relief and to take advantage if they do, contact your loan provider.
Even in the absence of the federal pause on requiring student loan payments, it generally makes sense to prioritize credit card payoff. Average interest rates on cards are among the highest charged on all forms of debt. Not only are average rates on student loans at the low end of the scale, but also you can generally deduct up to $2,500 of qualified student loan interest each year. (Certain high-income taxpayers are subject to limits on the deductibility of student loan interest.) This is an above-the-line deduction, meaning you don't have to itemize to claim it; however, you can't deduct credit card interest.
Need another reason to focus on paying off credit cards first? Student loans are often considered "good" debt because they represent an investment in your future. Generally, the same can't be said about credit card balances.
Two strategies for paying off multiple credit cards
When you're carrying balances on more than one credit card and want to work on paying off all the cards, you can follow one of two widely used paths. You can either pay off the card with the highest interest rate first or pay off the one with the smallest balance first.
If saving money is your priority, focus first on paying off the card charging the highest interest rate. Pay as much as you can each month toward that card while making minimum payments on all your other cards. Once you've paid off your highest-rate card, take the amount you were paying monthly on that card and put it toward the card with the next higher rate, and so forth, until you've paid off all your cards.
If you want a quick psychological "boost" from paying off a card more quickly, focus first on the card with the smallest balance. Pay as much as you can toward that card while making minimum payments on the other cards. Once you've paid off that first card, you can either move on to the one with the next-smallest balance or pay off your remaining cards in the order of highest-to-lowest interest rate.
Financially, paying off your highest-rate card first makes the most sense because it may save you more money over time. For help with this strategy, use the Snowball Debt Elimination calculator on your EY Navigate™ website or mobile app.
Stay current on student loans
Even as you prioritize paying down credit card debt, stay current on your student loan payments. If you're taking advantage of the extended federal pause, be sure to resume payments once the pause expires in October 2021. If you fall behind on payments, you risk defaulting on the loans, which could cost you fees, damage your credit and possibly result in lawsuits against you.
If you have multiple student loans, you can pay them off using one of the approaches outlined above for credit cards, keeping in mind that you're generally better off financially paying off the loan with the highest interest rate first. You may also want to explore consolidating multiple student loans into one. This can simplify payoff, lower the average interest rate you're paying and enable you to pay off your student loans more quickly.
Get more guidance
Your EY financial planner can help you explore ways to meet the challenge of paying off both student loans and credit cards. For example, your planner can show how using a budget can help you cut spending and find more money to put toward debts. Contact your EY financial planner today.
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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, legal or other professional advice. Please refer to your advisors for specific advice.
