Sometimes it's impossible to pay off all of your revolving debt at once. That leaves people with the question of which debt you should settle permanently when you have the cash to do so. It's sort of a good problem to have, but there's a clear answer in some cases as to which debts to settle first.
In this clip from Motley Fool Answers, Alison Southwick, Robert Brokamp and Fool alumna Dayana Yochim address Adam, who has credit card debt on which he's paying zero interest (smart use of a balance transfer, no doubt) plus a similar level of student loan debt -- and the ability to take care of one of them right now. Yes, it does make a difference to his credit score and his overall financial health which debt he retires first. And maybe he shouldn't do either...
A full transcript follows the video.
This podcast was recorded on July 12, 2016.
Alison Southwick: The next question comes from Adam. Adam writes: "I currently have about $8,000 in credit card debt (which has zero interest for about two years) and $8,000 in student loans. I currently have enough money to pay off one of them. Which one should I pay off, and do both debts have the same effect on my credit score?"
Robert Brokamp: First of all, depending on your income, the interest on a student loan can be tax-deductible, so that would be one thing to consider. And with any debt, you would look at the interest rates, and you want to pay off the higher interest rate first.
Alison: But if the [interest rate on the credit card] is zero for two years...
Dayana Yochim: Yeah.
Alison: ...it's pretty sweet.
Robert: You'll have to decide on those, too. And not that we ever would encourage bankruptcy or anything like that, but it is...
Alison: Where are you going with this?
Dayana: I know where he's going. Don't listen to him, Adam.
Robert: I am just saying when you make these decisions, it's very difficult to get out of school loans. It's much easier to get out of credit card debt.
Dayana: For it to be forgiven in bankruptcy.
Robert: Right, exactly.
Dayana: By forgiven, I mean angrily.
Robert: And if you want to destroy your credit score, and all that stuff.
Dayana: Right. So, yes, the tax deduction is very tempting, here. My immediate reaction to this question is pay off that student loan and you are golden. The student loan debt is the biggest problem that this generation has with building their financial future. If you've got the money to pay it off, great. Also, though, before that maybe you don't pay it off entirely. Do you have an emergency fund? Having some cash in the bank helps you avoid getting into credit card debt.
Also realize that those terms on the credit card (the two years of 0% interest) -- one screw-up, one bill paid late, one time going over the credit limit can erase that perk right away.
Alison: Oh, yeah. They say two years, no interest. If you mess up, they'll be like, "Never mind."
Dayana: Yes. You've got to be on your best behavior, and the terms only apply if you are up-to-date on your credit card. It's all about fine print that is really hard to read. And the other thing is [whether that applies] only to an existing balance that you rolled over. Are all new purchases subject to higher interest rates? If so, do you have another credit card that has a lower rate, maybe, that you can just use for your everyday purchases and things like that.
Alison: The bottom line, though, is you think he should pay off student loans. Bro, do you think you need more information to make that call?
Robert: No, I would say that because it is a higher-interest loan. It does depend, also, on how long he has. I mean, if he's going to pay it off very quickly, certainly just get it taken care of. But if it's going to take him four years to pay it off, then you've got to factor in that in two years that interest rate on the credit card is going to go up.
Dayana: So I would tell Adam to have a plan to pay off the credit card at least a month before.
Alison: In two years?
Dayana: Yes. Mark your calendar. Put up signs. All of that to pay it off before the 0% interest deal ends.
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