Move your student loan to a credit card? Wha-a-a-a?
If card rate is low and student loan rate is high, it can make sense
Which would you rather owe: credit card debt or a student loan? The answer seems obvious. Student loans are supposed to offer low rates and safety nets. For many, though, the interest is so high and the terms so onerous, they may be better off moving their educational debt to a credit card.
"The interest rates on some private student loans can be as high as on a credit card, and are subject to harsher treatment in bankruptcy," says Robert Shireman, executive director of the Project on Student Debt.
That means borrowers in certain circumstances may be better off settling the loan with a check from a low interest credit card.
"It feels like a shocking statement to make, but it's true," says Shireman.
Student loans are becoming an overwhelming financial burden for many grads. The average college student graduates these days $17,500 in the hole, up nearly 45 percent in 11 years. About 1 in 20 college students will default on his or her student loans, according to the College Board.
Student loan rates aren't that low, either. The current limit is 7.14 percent on Stafford loans, but two groups face much higher rates: those who consolidated their debt long ago, and the increasing number of students who use largely unregulated private student loans.
Many students consolidate their loans to capture lower rates, but -- in one of the peculiar rules that work against student loan borrowers -- they are allowed to do it only once. Then they are stuck. Those who refinanced their debt in the 1990s may be paying 9 percent or 10 percent in terms up to 25 years.
Worse are those who have private loans, which now account for 20 percent of student loan volume and charge rates of up to 20 percent.
The special conditions on student loans are not all for the borrower's benefit. Unlike credit cards, student loans will follow a person through Chapter 7 bankruptcy. They're in a special category with criminal fines, damages from drunk driving accidents and child support. Americans have an easier time walking away from an all-out Vegas binge charged to their credit card than their student loans.
For recent high school grads, this bankruptcy provision -- if they even know about it -- must seem like an unlikely scenario. But it’s becoming very real to many borrowers. Over the past several decades, more Americans filed for personal bankruptcy protection, reaching a peak of 2 million in 2005. Tougher rules have cut that number, but it’s climbing fast again.
Deanne Loonin, a staff attorney with the National Consumer Law Center, says that the borrowing of student loans is the only time society encourages teens to take on a decades-long debt commitment.
Until recently, loans guaranteed by the government (to the lender) enjoyed special protection from bankruptcy. But the recent bankruptcy overhaul had a little-noticed provision that extended these privileges to private lenders. As Congress investigates the growing student loan corruption scandal, Illinois senator Dick Durbin has introduced a bill that would remove the protection for private lenders.
Rolling the dice
So, given the harsh realities of the student loan market, would it be better for some borrowers to move their debt to a credit card?
Someone who switches to a lower rate and stays on top of payments could save thousands of dollars. You need to use an automatic payment option to avoid late fees and rate hikes. You should develop an obsession with your rate. The danger in all this is, of course, that your low rate could jump.
But someone who dumps his student loans on a credit card right before he files for bankruptcy could end up stuck with the debt again. Bankruptcy judges will look at your intent.
“I think it’s a dicey strategy,” says Cathleen Cooper Moran, a bankruptcy lawyer in Mountain View, Calif. “If it’s part of the plan to go bankrupt, I think that’s fraudulent.” The creditor could petition to file a nondischargeability action -- a way to ask the judge not to erase the loan.
Credit card companies will always look at charges right before the bankruptcy to see if the debtor went on a spending spree. The big question is how far back they will look. Moran says there is no set limit, but she tells clients it’s usually three to six months.
Even now, bankruptcy judges may sometimes wipe out all or part of a debtor’s student loans if he or she can demonstrate an undue hardship, but the practice varies widely, and even experts disagree on how difficult it is to convince a judge that a student loan is a hardship. Judges have chosen not to discharge student loan debt even in cases where the graduate became disabled, says Lois R. Lupica, a law professor at the University of Maine School of Law and a resident scholar at the American Bankruptcy Institute.
Moran says some judges consider hardship, but it is hard to prove. "Somebody fresh out of school who's healthy and has no dependents doesn’t have a good case," she says. "To get the debt discharged, they’ve got to be disabled or the court has to look into the future with some certainty" that they won’t be able to pay.
Student loans do come with some benefits: You can claim a tax deduction of up to $2,500 on your interest if you make less than $65,000 as an individual or $135,000 as a married couple. In lean times, you can get a forbearance or deferment. (A deferment is better; with forbearance you’re still accumulating interest.) Depending on the loan, you won't have to pay while you're in school or the Peace Corps. With student loans you have the option to pay a set percentage of your income or to stretch out the loans for 25 years. If you die, a student loan is forgiven.
There is some hope. Future grads will get better rates -- 6.1 percent this year dropping to 3.4 percent in 2011. By then students may have low enough rates and fair enough terms to make considering moving the debt to a credit card seem ludicrous again.
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