Paying for College: Student Loans or Credit Cards?

Research by student loan company Sallie Mae shows that in 2010, about 5 percent of college students paid an average of more than $2,000 in tuition and other educational expenses using a credit card to avoid taking out student loans. The same study showed that 6 percent of parents used credit cards to pay an average of almost $5,000 in educational expenses for their college children.

Is using credit cards a smart way to avoid college loan debt? Financial advisors almost universally agree the answer is no, but that’s not stopping thousands of families from using credit cards instead of parent and student loans.

Some families may think that all debt is the same; others may think they won’t qualify for college loans. So what exactly are the advantages of student loans over credit cards?

1) Availability

Particularly in recent years, as credit card companies have tightened their credit requirements in a pullback on soft lending that led to the foreclosure crisis, credit cards have become more difficult to qualify for, and they are primarily available only to consumers with strong credit. Many consumers with weaker credit have had their lines of credit reduced or eliminated altogether.

Federal college loans, on the other hand, are available with no or minimal credit requirements. Government-funded Perkins Loans and Stafford Loans are made to students in their own name without a credit check and without the need for income, employment, or collateral.

Federal loans for parents, known as PLUS loans, have no income requirements and only require that you be free of major adverse credit items: a recent bankruptcy or foreclosure, delinquent federal education loans, and 90 days or more delinquent.

In other words, don’t turn to credit cards just because you think you won’t qualify for school loans. Today, you’re more likely to qualify for a federal college loan than a credit card.

2) Fixed interest rates

While most credit cards have variable interest rates, federal student and parent loans are fixed-rate loans. With a fixed interest rate, you have the security of knowing that your student loan rate and monthly payments will not increase, even when general interest rates do.

Many credit cards will also penalize you for late or missed payments by raising your interest rate. Federal school loans keep the same rate regardless of your payment history.

3) Deferred refund

Federal student loans and federal parent loans can be deferred for up to six months after the student leaves school (nine months for Perkins college student loans).

With credit cards, however, the bill is due immediately, and the interest rate on a credit card balance is generally much higher than the interest rate charged on federal school loans.

If you’re experiencing financial hardship, federal loans also offer additional deferment and forbearance options that may allow you to postpone payments until you get back on your feet.

Even most private student loans (non-federal educational loans offered by banks, credit unions, and other private lenders) give you the option to defer payments until after graduation.

Keep in mind, however, that even though your payments are deferred, interest on these private student loans, as well as federal parent loans and federal unsubsidized student loans, will continue to accrue.

If the prospect makes you nervous about having slow-growing deferred college loan debt due to accumulating interest charges, talk to your lender about prepay options at school that may allow you to pay at least the interest each month in your school loans so your balances don’t get bigger while you’re still in school.

4) Payment options based on income

Once you start paying off your college loans, federal loans offer extended, income-based repayment options.

Extended payment plans give you more time to pay, reducing the amount you have to pay each month. An income-driven repayment plan lowers your monthly payments to a certain allowable percentage of your income so your student loan payments don’t eat up more of your budget than you can live on.

Credit cards don’t offer this kind of payment flexibility, regardless of your employment, income, or financial situation. Your credit card will require a minimum monthly payment, and if you don’t have the resources to pay it, your credit card company may initiate collection activities to try to recover the money you owe them.

5) Tax benefits

Any interest you pay on your parent or student loan debt may be tax deductible. (You will need to file a 1040A or 1040 instead of a 1040EZ to take the student loan interest deduction.)

In contrast, interest on credit card purchases cannot be deducted, even when a credit card is used for deductible educational expenses.

To verify your eligibility for any tax benefits on your college loans, consult with a tax advisor or see IRS Publication 970, “Education Tax Benefits,” available on the IRS website.

6) Student Loan Forgiveness Programs

While the only way to escape current credit card debt is to pay it off in bankruptcy, there are several loan forgiveness programs that provide partial or full student loan debt relief for eligible borrowers.

Typically, these loan forgiveness programs will pay off some or all of your undergraduate and graduate college loan debt in exchange for your commitment to work for a certain number of years in a high-demand or underserved area.

The federal government sponsors the Public Loan Forgiveness Program, which will cancel any remaining federal education loan debt you owe after you’ve worked 10 years in a public service job.

Other federal, state, and private loan forgiveness programs will pay off federal and private student loans for a variety of professionals: veterinarians, nurses, rural doctors, and public attorneys, among others.

Ask your employer and do an Internet search for student loan forgiveness programs in your area of ​​expertise.