You can potentially use money from one loan to pay off another. This is called debt shuffling, and it isn't typically recommended. If you're a college student who's thinking about using student loan money to pay off other debts, such as a car loan, it could lead to big trouble.
Paying Off a Vehicle With a Student Loan
Paying off your car loan with a student loan would be considered debt shuffling. This is the attempt to pay off debts with other debt – the money from one loan being used to pay on another. Borrowers usually do this to pay things off quicker, avoid interest charges, or avoid missed/late payments that could lead to default.
If you have extra money from your student loans, it can be tempting to pay off your car loan. However, this can break your student loan contract, depending on the language in it, and could mean trouble down the road.
There are potential legal issues to using your student loans, federal or otherwise, to pay off an auto loan. This could qualify as a misuse of the funds, and if found guilty, could lead to punishment, fines, or the inability to take on future student loans.
Additionally, if you need to file bankruptcy in the future, student loans historically aren’t allowed to be included or discharged in bankruptcy. So if you amass a large student loan balance that you used in order to pay off other loans, you may be stuck with the debt. Auto loans, on the other hand, can typically be discharged in bankruptcy if they meet requirements.
Student Loan Crisis and Interest
Remember that borrowing money to pay for school isn’t free – lenders charge interest on the loan. Paying off your auto loan with your student loans may feel like a good idea now, but it could cost you in the long run.
Federal student loans for the 2019-2020 disbursement dates have an interest rate of 4.53% for undergraduate loans, and 6.08% for unsubsidized graduate loans. Most student loans use a simple interest formula, meaning your interest charges stack up based on your remaining loan balance.
An interest rate around 5% doesn’t sound so bad at a glance, but when you consider the average student loan debt, it can be staggering.
The average student loan debt in 2020 has reached $38,792, as reported by Experian. A study conducted by New York Life found that it took borrowers an average of 18.5 years to pay off their student loans.
If you have a student loan balance of $38,000, with a 5% interest rate for 18.5 years, you’d likely be paying around $20,320 in interest charges if you stay on schedule. That’s a grand total of $58,320 for your student loans!
If you’re considering accepting additional student debt or aid to pay off your existing loans, consider it thoroughly, because it adds up quickly, and the resulting fines for getting caught may outweigh the benefit to you now.
Advice on Vehicle Financing
Instead of shuffling your debt, try to take on a short loan term for your car loans. The shorter the loan term, the less interest you pay over the course of the loan. Choose an affordable car that has a monthly payment you can afford month-to-month without breaking the bank.
If you’re on the edge of default with your current auto loan, consider asking your lender for a deferment plan to temporarily pause payments, or refinancing the loan to get a more manageable monthly payment.
Additionally, maintaining an active installment loan (such as a car loan) is good for your credit score. By paying off all your outstanding loans in lump sums, you could be missing out on potential positive payment history that improves your credit score. Your FICO credit score considers payment history the most important part of your overall credit rating, so the key to building a good credit score is having a long-standing, timely payment history.
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