Tell Me Why This Financial Strategy Won't Work (or Will It?)

Factual Questions
1

I’m providing housing and some financial support to an adult relative. The AR, we’ll call them, has some student loans. It’s nothing too onerus: a current total of about $6,000, with a payment of $80.00, which is actually the smallest of all AR’s monthly expenses.

The AR is not great with money, and when they find themselves in dire financial straits, their tendency is to latch onto quick-fix solutions, especially ones that have the potential to implode in spectacular fashion. Recently, the AR and I went over their budget, and confirmed that, even at the best of times, income is *just *barely covering outgo - and we’re not currently in the best of times. So the AR decided it would help if they put their student loan debt on their credit card, because the card currently has a lower interest rate than the loan.

Fortunately, I found out about this plan before the AR could go through with it, and brought up the objection that the rate on the loan is locked in, while the credit card company can change theirs at any time, and if there’s suddenly $6000.00 on the card, they may well decide that now is a good time. The AR protested that the interest rate on the card has actually gone down since they got it. I responded that this is no guarantee it will continue to do so. But this discussion happened when the AR was on the way out the door, and so we agreed to table the discussion until later. We’re scheduled to have a talk about finances on Friday, and this will be part of that.

So, what I want to do before then is a) confirm that this is a sucky idea (or, if it’s not a sucky idea, figure out how would it work) and b) gather as much information as I can for AR about why this is a sucky (or fabulous) idea. So far, I’ve only got notes in the “Sucky” column:

  1. It’s a huge risk. There is no guarantee that the credit card interest rate will remain the same for the 6-7 years that it will take to pay off the balance, and indeed, this strikes me as highly unlikely.

  2. It may not even be possible. The plan would require that the credit card minimum payments be the same as the loan payments - $80.00. I don’t know how the AR’s minimum payment is calculated, but my understanding is that most cards ask for 4% of the balance, which would be $240.00. Given that the AR can barely afford the $80.00, this puts it right out of the question.

  3. Even if it is possible, and the risk pays off, it doesn’t offer much benefit, if any. Sure, the AR might pay a little less overall, but that would only shorten the total time to pay it off, not put money in their pocket now. And since student loan interest is tax deductible, there might be no net savings, or even a loss. I’d really like to be able to calculate this, though, rather than just saying, “As you can see, it might not save you anything.”

Part of the problem is that I don’t know the interest rate on the card. I’m pretty sure the rate on the loan is in the neighborhood of 6-7%, but I’m not sure about that either. But regardless of the actual amounts, are there *any *numbers I could plug in that would make this plan a good idea? And are there any other issues, large or small, I’m overlooking?

To be clear, my goal is not to prove AR wrong, but to protect their finances, and by extension, my own. If I’m just missing that this is actually a low-risk move with a high potential benefit, I definitely want to know. So - thoughts?

2

Has AR considered asking for a forbearance on their student loan? Because you don’t get that (very often) with a credit card…

3

Another vote for forbearance. Since the issue is monthly income/outgo, a slightly smaller interest rate isn’t going to help much.
Furthermore, I believe that you can write off education loan interest if your income is low enough.

4

You can point out that unless the AR makes more than $70,000 adjusted gross income if single the interest on a student loan is deductible, and is deductible even if he doesn’t itemize. If filing jointly the income restriction goes up to $145,000.

5

I’ve suggested that several times, but AR seems to think it’s a horrible, last-resort kind of thing. In fact, when I pointed out that the card’s interest rate might go up, AR’s angry response was, “Fine! Then I’ll just get a deferment!” as though I would say, “NO! Not that! Do whatever you like, but for the love of God, don’t defer!”

At the time, I didn’t say anything about it one way or the other, because frankly, a deferment wouldn’t really help, even in the short term; it would only be a temporary band-aid on a fairly permanent gaping, festering wound. But I do intend to bring it up again on Friday, as in, “If the student loans were the problem, then a deferment would be a good solution. Unfortunately, the loans are the least of your worries…”

Is there a way I can calculate this out for AR? As in, “The savings with the lower interest rate will be $X, but the benefit from deductions over those 6 or 7 years will be $Y”?

6

This strikes me as a very bad plan. I was going t point out that you can deduct the interest, but others have already posted that.

The one thing AR might be able to do is transer the balance from the current card to a “zero interest for X months” card (if s/he qualifies) as often as needed to avoid the interest. However, if AR thinks he/she is going to just keep paying the $80 a month, that’s 75 months to pay off 6Gs so over 6 years of jumping from card to card. That’s a long time to have that balance sitting on the card and hogging credit that AR might need in an emergency. Plus, it’s not unheard of for a credit card company to up an decide to drop your credit line to something below your balance, and suddenly you have to come up with a big chunk of cash to pay it down. The nice thing about a student loan payment plan is you’re locked in (as you mention) and with electronic payments, you can kind of set it and forget it.

I’d be evaluating many other expenses before messing with my student loans.

7

  1. What student loan has a higher interest rate than a credit card? That would be the first thing to investigate. Who holds the loan? Why does the interest on the CC change? Is it linked to prime?

  2. Why are expenses so high or income so low? Sounds like AR needs to bite the bullet and either scale down their lifestyle or get a second job.

  3. A forebearance may be possible, but does not address the basic problem that AR cannot manage money and this whole “student loan on a credit card” should be the least of their problems. They need a holistic plan that addresses budgeting, the loans, income, etc. Without that, none of their plans will work.

8

This depends on what tax bracket he is in and it will be easier to put it in terms of interest rate than money saved. For example, I am in the 25% bracket for the feds and 7% for state, so my student loan interest rate is basically knocked down by 32%, i.e. 3.625% is effectively 2.47%. The more money you make the more it helps, so it sounds like it isn’t going to help him all that much.

I think your point #2 is very important. Even if the minimum payment is only 2%, that is still more than he is paying now.

He should call the loan servicer and see what options are available. There may be other options like lengthening the terms or such that will generate longer term relief than a six month forebearance.

9

Suppose AR’s taxable income is $15,000/yr, in which case his tax rate is just over 12%. With $6000 at 6%, that’s about $360 in interest for the first year; if AR deducts that from his taxable income, he’ll save about $50.

If the credit card interest rate is 5.2%, then his first year of interest is $310, but he won’t get to deduct this amount from his taxable income. So if his student loan (with its tax-deductible interest) is at 6%, and the card is at 5.2%, then it’s a wash.

EDIT; forgot to include state tax. This would mean an even LOWER credit card rate for break-even.

(This was an example; you can supply your own income/interest rate numbers to better reflect AR’s situation as you see fit.)

That doesn’t consider the other issues you mentioned, the two biggest being the minimum payment amount, and the fact that AR will be completely at the mercy of the credit card company WRT the interest rate. You can probably call them and find out what the minimum payment amount would be for a balance of $6K, but the interest rate is a complete wildcard. Since many cards out there have double-digit rates, I would be very, very surprised if AR’s card stays below 5.2% for any significant length of time.

10

They’re Sallie Mae and Stafford. I’m not sure who holds it; I think it’s consolidated somehow. I don’t know what either rate is - I *suspect *that the loan is between 6 and 7%, and the card is probably just below that, by some tenths of a percent or something. My understanding is that CC companies can pretty much raise their interest rates at any time, and often do. I may be wrong about this; I know there was some relevant legislation last year, but I don’t know the details.

Oh, hell yes. We’ve been working on that, for a couple of years now. How AR got into this mess is a whole other story, but the long and short of it is that I haven’t been driven to the point yet where I would kick AR out, so I’m somewhat at the mercy of their financial decisions.

Tell me about it. And let me tell you about the 18 or so plans I’ve drawn up over the past few years, and the time I’ve spent hand-holding, prodding, berating, and cajoling AR into action. The real root of the problem is that AR, while indeed an adult in the strictest sense, has some developmental issues that complicate efforts to manage money, and life in general, for that matter. But AR, being a legal adult, can and will do as they please.

Thanks! You rock! That’s exactly what I was looking for. I’d hope *this *would persuade AR, if nothing else. But I hoped for a pony, once, too.

11

What if you laid out your financial situation to AR, and compared it to his/hers. Then just simply point out that your track record is more proven than theirs - and therefore if your gut tells you that putting a student loan on a credit card is a bad idea, then its probably a bad idea.

I’m half serious with that. However, more seriously:
My understanding is that student loans are relatively VERY flexible about payment options. Once of the reasons I never consolidated my student loans to the lower APR years ago was because my initial reading up on the consolidated loans indicated that they would not be as flexible with repayment if I ran into some hardship.
It would appear to me that AR could easily be in a similar boat if he put the loans on a credit card. It is obviously a rough time out there now, so people (and specifically, AR) needs as much flexibility with repaying loans as possible - and locking into a credit card that might jump interest is the exact opposite.

Also, point out that his money management is probably a large part of the reason why he’s always feeling the need to get rich. Obviously his money handling logic is faulty :stuck_out_tongue:

12

I don’t think any of the other responses addressed the the cost of putting the loans on the credit card in the first place. I doubt that you can make your student loan payment by credit card; he would probably have to take a cash advance. Most cards charge a 3 - 4% fee for a cash advance. Many cards charge a higher interest rate on cash advances than on other transactions. One of both of those factors will likely torpedo the scheme before it gets off the ground.

13

It seems you don’t want to get into too much detail but if they have a developmental diasability, there may be assistance your state can provide. In addition, the state must provide services to a person with an IEP until age 22 if they haven’t graduated from high school which may be the case if the student loans were for a vocational or 2 year school after they turned 18.

I’m ready to be flamed for this, but the attitude that you have about helping them while simultaneously they can do what they please may be part of the problem. It cannot be 100% all on you. There is a lot more going on here than merely who they will end up owing the $6000 to and without some fundamental change all of this discussion is meaningless.

I have a master’s in special ed with a concentration in transition studies so if it is an issue about a person with disabilities and post-secondary life, feel free to PM me and maybe I can advise you on getting some assistance in working on this problem.

14

I find it very, very hard to believe that a person in frequent financial trouble has a CC with a rate around 5 or 6% (Stafford Loan interest rate is 5.6%). That would be an extraordinarily low interest rate if it wasn’t promotional rate (1st 6 months! or whatever). Such introductory rates usually bump back to something like 12-15% as soon as one payment is missed, or the introductory period is over, whichever comes first.

15

Thanks, Saint Cad, I appreciate your post. I don’t want to go into too much detail here, but only because it’s not relevant to the particular issue. While I’m definitely working on how to handle the bigger picture, I’m also trying to put out (or ideally, prevent) the small fires as they pop up. The student loans are indeed the least of our worries, but I also don’t want to get stuck paying a couple hundred bucks a month on AR’s CC for the next few years. And the best way I’ve found to prevent things like that from happening is to show AR exactly why it won’t work.

I may PM you later, but suffice it to say that AR is well beyond the age of mandatory assistance, and the problems aren’t anywhere near bad enough for me to apply for custodial rights against AR’s will or anything like that, so I’m not sure there’s really anything to be done.

Yes, and I’m not sure it’s true, but in this case, it’s certainly possible. The thing is, AR has always been bailed out in the past by another family member who no longer has the resources to do so, and by a few random windfalls here and there (a settlement from a car accident, a life insurance benefit). This makes the current situation even harder to address, because AR doesn’t really acknowledge their previous good fortune, and tends to say, “Well I was able to live on X then, so it should be enough now!” This is why presenting hard numbers is key. AR can argue with my opinion, but they can’t argue with the math.

16

I’ll agree with the previous posters:

No efffen way a credit card company offers a card with a permanent 5% or less rate. they are notorious for their 18% to 29% rates.

It must be an introductory rate, which will bump up to 29% in 6 months.

No effen way they allow cash withdrawal (as someone pointed out, the only way to pay the student loan) at the “low intro rate”. I bet it will be 29% from the start for cash withdrawals. Think about it. Basically they are offering you (or AR) a cash loan below what the bank charges for actual, secured loans. No, they won’t.

No effen way a problem financial whiz with minimal income who is barely getting by gets a card with a permanet 5% interest rate. They are the choice target for the 29% cards.

If AR actually qualifies for a card with a $6,000 limit but their concern and difficulty is a $6,000 loan with a $80 payment - then the company that issued the card and their departments that approved it should be jailed for racketeering. They are deliberately setting AR up to fail. Jeez, if the whole country operated like that it’s a wonder you have a functional banking system. Oh, wait…

If AR lives with you (presumably subsidized or free accomodation) and still has trouble making ends meet, then either their income or their outgo needs serious adjustment. This is why some people do what’s known as “working several jobs”. It’s difficult to imagine a second part-time job at Starbucks or McDonalds for a few shifts a week being a hardship, and it would easily provide the $80/month plus to pay off the loan twice as quick.

(I know - you’ve probably had this talk but they’d rather keep bar-hopping or buying Marvel Superhero collectibles or whatever…)

The rule of thumb is pay off the highest interest-rate loans first. If this is the highest-rate or biggest loan, then AR must have some mighty interesting finances. Again, they need to fix their income if $80/month is of any concern.

The most appropriate financial rule I heard was - “if things can’t go on like this… odds are they won’t.”

17

I read your recent reply after posting…

Sorry if I sound harsh. I know 3 families who subsidised their kids far too long. One was retiring a few years after me, and remarked “my son thought they were not allowed to turn off his gas for unpaid bills during the winter. he was wrong.” Daddy bailed him out, once again. 30 years old, living in the house daddy bought; daddy pays half his bills; daddy seriously wondered if his daughter got pregnant because she was afraid the son and son’s wife would get a bigger share of daddy’s subsidies with a child. now he has 4 grandkids to support too.

It never ends.

It sounds like mama or papa ran out of money to subsidize AR and now you are being the older sibling. I suggest you tell them - “your finances are your problem, but you get nothing from me. If you need a place to live, you can live here. If you make money, you pay X in rent. If you can’t get a job, you still don’t get any money; you crash, burn and go bankrupt all on your own, I just make sure you don’t freeze or starve. (Provided you don’t steal from me…)”

Frankly, what do you care if they default on a credit card, or even a student loan? It does not affect your credit score. Subsidising a supposed adult does not teach them good money habits; it just means you will have to do it even more later.

If mama won’t talk to you because you let her little darling go without beer money - tough. You don’t owe mama anything either. At this point you’ve more than proven your willingness to help. It’s time to reinforce the learning experience.

The assumption that you will pay off the credit card if they mess up says it all. Why, why, why? Even the mama birds push the little critters out of the nest when it’s time…

Sorry if I sound a little harsh - and made assumptions that are very likely not correct - but I saw this too many times where I worked. At a certain point everyone has to fly on their own…

18

No, you don’t sound harsh at all, and in fact, this is more or less exactly what I’ve done. The thing is, while I’m not ready to kick AR out, I sure as hell don’t want them living with me forever, either. But if they’ve got the not-freezing and not-starving covered, they well may decide to do just that. And if their credit tanks, they won’t be able to get an apartment, even if they could afford one. So I see it as being in my own best interest to protect AR’s credit, at least until I can get them out the door.

That said, outside of bills, AR actually doesn’t spend very much money at all. They just don’t make much either. But if they were to go racking up CC debt on anything remotely less than necessary, I’d likely bail them out the once (as a loan, and not a gift) with the warning that I would never do so again.

Oh, and thanks to you and others who pointed out that you can’t pay off the full amount of the loan with a CC, and that AR would instead have to get a cash advance, with huge fees to boot. That’s officially the nail in the coffin of this sucktastic plan.

19

I also agree that md2000 isn’t being harsh at all. If you continue to enable people to run up debts and never balance their expenditures to their income you’re not really helping them at all. Until they can make their personal finances balance the hole will just keep getting deeper.

Basically I think your initial analysis is correct and you should strongly suggest to AR that their plan is not a good one.

20

Am I not understanding how student loans work? I am not familiar with them…

If I have a car loan at 7% and my monthly payment is $250, that $250 goes to cover principle + interest. No matter what I use to pay that monthly payment, I am paying interest on my loan.

If I have an absurd credit card APR of 5%, and I use that card to pay my $250 monthly car payment, and then do not pay off my credit card, I am charged the 5% APR on my $250 charge.

By using a credit card to make my car payments, I have paid my 7% to the car loan and my 5% to the credit card. I have not saved 2%…I’ve paid 12%.

Is this not how student loan works? Do you not pay interest if you make the monthly payment or something?