Paying for Tuition with a Credit Card or an Unsubsidized Stafford Loan
August 20, 2012
I am a graduate school student at a university where subsidized loans are no longer an option. Only unsubsidized. I am now faced with a decision: which would be a better option for me to use to pay for my tuition this fall, taking out unsubsidized loans or putting it on my credit card (9.9% interest)? — B.R.
Subsidized Stafford loans are no longer available for graduate and professional school students at all colleges and universities. The Budget Control Act of 2011 eliminated these loans effective July 1, 2012 to address a funding shortfall in the Pell Grant program. Graduate and professional students can still borrow the same amounts from the Stafford loan program, but the loans will be unsubsidized. (Some colleges may award the Perkins loan, a subsidized loan, to graduate students, but there isn’t much funding available and the money is restricted to students with exceptional financial need. Most of the Perkins loan money is awarded to undergraduate students.)
The unsubsidized Stafford loan has a 6.8% fixed interest rate. The Grad PLUS loan has a 7.9% fixed interest rate. These interest rates are lower than the interest rates on most credit cards, which currently average about 11%. Interest rates on credit cards are usually variable and may increase significantly over the life of the loan.
Repayment on a credit card debt begins immediately. The minimum monthly payment on a credit card is usually a percentage of the current balance, typically 2% to 5%, and always at least the new interest that accrues. This means the monthly payment will start off higher and gradually decrease as time passes. The initial minimum monthly payment on a credit card is 2 to 4 times the standard monthly payment on a federal student loan.
Repayment on federal education loans is usually deferred until after graduation. In some cases there is a 6 or 9 month grace period after graduation before repayment begins. Borrowers have the option of making payments during the in-school and grace periods, since there are no prepayment penalties on student loans. Some borrowers will pay the interest as it accrues to prevent the loan from getting larger. If a borrower does not pay the interest as it accrues, the interest is added to the loan balance, increasing the size of the loan by about 1/5 to 1/4. Federal education loans also offer other deferments, such as the economic hardship deferment.
Federal student loans provide several repayment plans, including standard repayment, extended repayment, graduated repayment and income-based repayment. Standard or extended repayment have a monthly payment based on the length of the loan term. This payment does not change. With graduated repayment the monthly payment starts off low, at or slightly above the new interest that accrues, and increases every two years. With income-based repayment the monthly payment is based on a percentage of the borrower’s discretionary income and changes each year based on changes in the borrower’s income.
Federal student loans also offer public service loan forgiveness, a benefit that is not available from credit cards.
Up to $2,500 in student loan interest may be deducted on federal income tax returns as an above-the-line exclusion from income. This deduction can be claimed even if the taxpayer does not itemize. Interest on credit cards, like interest on any mixed-use loan, is normally not deductible. However, credit card interest is eligible for the student loan interest deduction if the credit card is used solely to pay for qualified higher education expenses. (A single nonqualified expense is sufficient for the credit card interest to become non-deductible.)
Credit card debt can be discharged in bankruptcy (except when used solely to pay for qualified higher education expenses), while student loans are almost impossible to discharge in bankruptcy.
Many colleges, especially public colleges and larger colleges, will charge a convenience fee for students who pay for tuition with a credit card. These fees cover the cost of the merchant fees charged by the credit card issuer. Other colleges no longer accept credit cards to avoid the merchant fees.
Because of such processing fees, using a credit card to collect frequent flyer miles or other rewards is no longer cost effective. Also, some rewards cards have exclusions for college tuition and fees, so students should read the fine print before relying on a rewards card to pay the tuition bill.
According to Sallie Mae’s How America Pays for College 2012, only about 4% of parents and 3% of students use credit cards to pay for college costs.