September 13, 2009

Bad advice form Suze Orman : Pay off student loan before credit card.

I watched an episode of the Suze Orman show from two or three weeks ago and she gave some advice to a caller that I considered pretty bad advice. The caller in question had a buyout offer from their employer of about $90k after taxes and they asked what to do with the money. They had about $60k in credit card debt and $27k in student loans at 6%. Suze told them to pay off the student loans, about half the credit cards and keep the remaining $30k or so in cash. That would leave them with about $30k in credit card debt and $30k in cash.

Suze Orman told the viewer to pay off their student loan before their credit cards. I consider this pretty bad advice.

The reason that Suze cited for this decision was that student loans are not dischargeable in bankruptcy. It is in fact true that student loans are very difficult if not almost impossible to get rid of in bankruptcy. But that is not a good reason to pay off a 6% debt before your credit cards. The caller in question did not say what the interest rate was on their credit cards but its likely that its in the 10-30% range. The average rate for credit cards is 14%

What happens in bankruptcy should not be your primary reason for making financial decisions. You should not be planning for bankruptcy. Bankruptcy can happen to even the best of us if we get in the wrong circumstances and have some bad luck. So while you should be aware of what bankruptcy could happen, bankruptcy should not be the driving decision behind your financial planning.

Paying off the lower 6% student loan first will cost them money. If we assume they have the average interest rate of 14% on their credit cards then paying off the 6% student loan first will cost them an extra $2,400 a year in interest on that $30,000. Even if the caller had a particularly low 9% rate on their credit card then they'd still be paying $900 extra by paying off the student loan before the credit cards.

Lets say they had 14% rate on their credit cards and paid $600 to the loan monthly. It would take them 76 months to pay off the debt. If they instead had the student loans at 6% and paid $600 a month they could pay it off in 58 months. So over the life of the loans they'd be paying about $10,800 more with the credit cards and carry the debt for an extra 1.5 years.

Do you think its worth an extra $10,800 to carry a credit card debt instead of a student loan simply because how the debts are treated in bankruptcy? Absolutely no, it is not!

Suze should not be telling people to pay off relatively low interest student loans before higher interest credit cards simply based on the bankruptcy laws.

2 comments:

  1. That does seem like particularly odd advice. Are you sure that you heard the entire context of the conversation? The reason I ask is because if for some reason it was mentioned that bankruptcy was imminent, than I suppose the advise would actually be pretty wise.

    In the absence of bankruptcy, it would seem that paying off the credit cards would definitely be the better way to go for two reasons. First, the interest rate is almost certain to be higher on the credit cards. Second, paying off the credit cards is a better move when it comes to liquidity. If you take $30K and pay off the student loan and then need some of that money back for some emergency purpose, it's doubtful you will be able to obtain another student loan. If you use it to pay off the credit cards, then in a worst case scenario you could always borrow it back again on the cards.

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  2. S.B.,

    I saw the whole show so if there was more context to it then they didn't show us. They were not in bankruptcy or going into it and there did not seem to be any particular reason to think they'd be heading to bankruptcy.

    Jim

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