Using plastic to pay off student loans: A bad idea
Card debt is dischargeable, student debt isn't, but don't do it
By Minda Zetlin | Published: July 1, 2013
With federal loan interest rates for students in need doubling today to 6.8 percent and private student loans averaging between 8 percent and 12 percent, would it ever make sense to pay off student loan debt with a credit card?
Using one or more credit cards to get out from under the burden of student loan payments can seem tempting, especially in terms of racking up rewards points, and low or no interest for a year or so with a 0 percent promotion. And unlike student debt, credit card debt is much easier to get rid of. Student loan debt is extremely difficult to get discharge in bankruptcy, for example, while credit card debt can be shed relatively easily.
But wait, experts say. Shifting student debt to credit card debt rarely makes sense financially, and if you go into it thinking you may eventually discharge the debt in bankruptcy, you're at best betting on yourself to fail, and at worst, committing fraud.
Yet, for a few people in dire straits, student loan conversion to credit cards has been a way to escape debt.
We'll take a look at the reasons why it's a bad idea -- and then outline the pitfalls and occasional successes on this rocky path.
First, the financial part: It costs money to shift debt, and if you thought student loan rates were high, wait until you see the average credit card rate. Once promotional rates expire, the average credit card rate is almost 15 percent. Together, the fees and the higher rates more than erase any short-term gain.
With the rise in student rates, we asked experts to look at whether it was ever a good idea to shift student loan debt to credit cards, and they gave us three reasons it isn't:
1. You might not get
away with it.
"Any refinancing of a qualified education loan is still considered a qualified education loan," says Mark Kantrowitz, publisher of Edvisors.com, a network of sites offering educational resources. "Thus if someone were to pay off student loans with credit cards, the credit card debt would be non-dischargeable in bankruptcy.
And, he says, paying off a student loan with credit cards with the intention of filing for bankruptcy afterward would be considered fraud. "It would run afoul of the anti-abuse provisions in the U.S. Bankruptcy Code. A bankruptcy attorney who knowingly encouraged a client to do this could lose his law license."
The upshot is that you stand a very good chance of having the student loan debt remain your responsibility even after the expense and hardship of a bankruptcy filing, despite the debt being rolled over to a credit card. And you may get sued for those actions as well.
2. It'll cost you.
To begin with, most lenders don't accept credit card payments. "The U.S. Department of Education accepts credit cards, but only for borrowers in default," Kantrowitz says. Private lenders are free to accept credit card payments, but many don't. "Some private student loan programs accept credit cards for international students," says Kantrowitz. Either way, "In most cases the lender will tack on a service or convenience fee to cover the cost of the fees they get charged for accepting a credit card," he says. It may be possible to use a credit card balance transfer check or a cash advance, but these approaches almost always come with their own fees, typically 3 percent of the amount for a balance transfer and up to 5 percent for a cash advance.
Any refinancing of a qualified education loan is still considered a qualified education loan. Thus if someone were to pay off student loans with credit cards, the credit card debt would be non-dischargeable in bankruptcy.
Then there are interest rates. Federal student loans are currently at a 6.8 percent fixed rate, and are dispersed according to financial need. (Note: Since lawmakers hit a stalemate on June 28 to prevent the 3.4 percent interest rate on subsidized loans from doubling on July 1, it is likely Congress will revisit the issue after its summer break. On the table, however, is another proposal to tie student loan rates to market interest rates.)
Private student loan rates are even higher. At the end of 2011, the last year for which the Consumer Finance Protection Bureau has released figures, average private student loan interest rates were just below 8 percent and variable -- meaning the APRs can rise as interest rates rise. Compare that with average variable credit card interest rates of about 15 percent. The bottom line is that, unless you can pay off your loan within the zero or low introductory rate period, which can average from six to 24 months, your interest rate (and hence, your payments) will then most likely be higher with a credit card.
3. You may have
If you have a federal student loan, you should explore an income-based repayment plan before resorting to credit cards. These plans limit your monthly payment to 15 percent of discretionary income over the poverty line for your family size. In 2013, the poverty limit is $11,490 for a single person or $15,510 total income for a couple or family of two. The poverty limit goes up from there by $4,020 for each additional family member.
If your loan is large, it might seem as if it will never get paid off this way, but if you make consistent and timely payments for 25 years, any balance will be forgiven, and it may be forgiven in only 10 years if you work for the government or a 501(c)(3) nonprofit organization.
"With a federal loan, income-based repayment will always be your best bet," says Zac Bissonnette, author of "Debt Free U." "The way those formulas work is very, very kind." (For more information, visit the U.S. Department of Education Office of Federal Student Aid.)
If you have a private student loan, this isn't an option. "There is some legislation that would allow private student loans to be discharged in a bankruptcy, but it's in the very early stages," Bissonnette says. For now, your only choice is to negotiate with your lender and try to work out a repayment plan, he adds. "And tell everyone you know in high school to stay the hell away from private student loans," he says.
A third alternative may exist for both federal and private student loans: Getting a court to erase your debt because of circumstances that limit your earning ability now and over the long term, creating undue hardship on you and your family if you are forced to repay. It's a difficult test to meet.
However, a May 2013 federal appeals court decision may indicate things loosening up slightly. Michael Hedlund went to law school but failed three times to pass the bar and had to give up his law-intern job for a lower-paid career as a counselor. He asked a bankruptcy court to forgive his student debt because of undue hardship. After a 10-year court battle, the U.S. Court of Appeals for the Ninth Circuit let him escape all but $32,000 of the $85,000 owed a private lender.
As these cases illustrate, the case for undue hardship can be tough to make. But very few people even give it a try. Earlier this year, Jason Iuliano, a doctoral program student at Princeton, conducted a study of cases where student debtors filed for bankruptcy. He found that only 0.1 percent -- one in 1,000 -- made the attempt, but of those who did, nearly 40 percent were successful. The message is clear: If you're in dire financial straits and filing for bankruptcy, asking for student loan forgiveness is a long shot, but it's probably worth taking that shot.
Still considering credit
Are you convinced yet that moving your student loan debt to credit cards is a bad idea? If the answer is no, and your situation is so dire that you may eventually have to file for bankruptcy down the road, then consider this: It's fraud if you intended to file bankruptcy at the moment that you repaid your student debt with credit cards.
Did you commit misrepresentation by converting the student loan debt to a credit card? If you intentionally did it with an intent to file bankruptcy, that's fraud.
If you planned in good faith to pay back the loan you transferred to plastic, but then found you couldn't, or your financial circumstances changed, that isn't fraud. "It all comes down to the intent of the party," says bankruptcy attorney Richard Gertler. "Did you commit misrepresentation by converting the student loan debt to a credit card? If you intentionally did it with an intent to file bankruptcy, that's fraud. But if you had no ill intent and continued paying it down until some circumstance prohibited you from doing so, then there was no intent to defraud the company."
In any case, the discharge may well go through unless the credit card company actively opposes it. "If the credit card company objects, it becomes nondischargeable debt," says Paul S. Kuzmickas, a bankruptcy attorney with Luftman, Heck & Associates. "The key, however, is that the busy, swamped credit card company has to notice it." It might not, he says, because they don't generally send representatives to bankruptcy filings.
If you do move student loan debt to credit cards and later file for bankruptcy, here's how you'd have the best chance of discharging that debt.
- You get lower
interest than for your student loan.
Transferring a low-interest loan to a higher-interest credit card will work against you if you file for bankruptcy. That's because a court may try to determine your intent when paying student loans with a credit card -- whether you had a good faith plan to pay them off but fell on hard times, or if it was all part of a scheme. Whatever your actual thought process, the fact that card interest rates are typically higher than most student loan rates can make it look like bankruptcy was your intent all along. "There would be no other reason to do the transaction," says Bissonnette. "The only purpose would be attempting to essentially take out a loan under false pretenses." One reason his client won her case against the credit card company, Gertler says, was that her credit card interest rate was slightly lower than the rate she was paying for the student loan.. "Let's say your student loan interest rate is 7 percent, and you put it on a credit card for 12 percent or more. I would argue [that you were planning fraud] if I represented the credit card company, because no logical person would want a higher interest rate."
- The credit card
company invites you to do it.
If you see a promotion by a credit card company suggesting you use the card to pay student loan debt, go for it. That's what a client of Gertler's did some years ago. When she later lost her job and filed for bankruptcy, the credit card company cried foul. But Gertler confronted the company in court with its own literature inviting borrowers to use its card to pay off student loans. The case was dismissed.
Be prepared for a
Make no mistake: Moving student loan debt to one or more credit cards and then attempting to discharge that debt in bankruptcy is not for the faint of heart. There's a very real possibility that you'll be sued and will have to defend your actions in court. For many people, the thought of a court battle, and the embarrassment and legal fees that go with it, is enough of a reason not to try this.
But if that doesn't describe you, then it may be worth the risk. Gertler notes that, even if you are sued, you may still be better off than you were before. Depending on your overall financial outlook, you or your attorney might persuade the credit card company to forgive at least part of the debt, he says. "I would pick up the phone and call the other lawyer. I'd say, 'We're going to spend $10,000 apiece litigating this case. What if we make $50,000 nondischargeable and discharge the rest?'"
In most cases, they'll negotiate, says Gertler. "A person who's lost a job, has little or no equity, and is unable to pay the credit card debt after several months is perceived as a risk," he says. "They will make deals.
See related: Will card debt scare off student loan lenders?, Steps to make good on a defaulted student loan, Unhappy with student loan terms? Consider these options
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