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Why Repaying Federal Student Loans on a Credit Card Is a Bad Idea

The long and sometimes painful process of repaying student loan debt can sometimes lead people to consider creative ways to relieve the financial pressure or work the system to gain some extra reward for their efforts.

Some student loan borrowers may be tempted to use credit cards to make installment payments -- or even pay off entire balances. While the U.S. Department of the Treasury doesn't allow student loan servicers to accept credit card payments, some borrowers still look for ways around these limitations. Student loan servicers are companies, such as Navient or Nelnet Inc., that maintain loans for the Department of Education and perform tasks that include collecting payments.

One way around the restriction involves the use of a third-party bill paying service that will charge your credit card and send a check to your loan servicer. Balance transfers are another option, although not all credit card issuers make it possible to complete a direct transfer of a student loan balance. Another way is to use a cash advance on your card and move the money into a checking account, so you can draw on the funds to make loan payments.

As you might imagine, there are some risks student loan borrowers should consider before attempting any of these possibilities. The potential dangers should be carefully weighed against any of the benefits.

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[Read: What to Know About Federal Student Loan Repayment Plans.]

Here are some of the top reasons people consider using credit cards to repay their student loans and the associated risks with these strategies.

Earning reward points. On the surface, it may make sense to maximize a credit card reward program by using it to pay for as much as possible while keeping spending within budgetary limitations.

But the Student Loan Ranger doesn't advise this strategy. For starters, it's worth repeating that a third-party bill paying service is likely necessary. These companies typically charge a transaction or convenience fee. Plastiq, for example, tacks on a 2.5 percent transaction fee for each charge.

While the fees may not seem like much of a problem at first glance, the additional cost can add up over time and offset the value of any earned rewards.

The average student loan balance for a college grad who borrowed to pay for school was $28,400 in 2015-2016, according to data from the College Board. Given that the current interest rate for a federal undergraduate loan is slightly more than 5 percent, it's unlikely that anyone would want to deliberately add to their balance or total cost of repayment. Coupling a 3 percent fee with the average 5 percent interest rate directs a greater percentage of your payment to something other than your balance.

On the flip side, some have reported success using cash-back bonuses to pay down their student loan debt when the card issuer provides the reward in the form of a check. This is possible in some situations where there's a sign-up bonus for new cardholders.

But there's often a deadline-driven minimum spending amount required to qualify for the check. Chase Sapphire Preferred, for instance, requires a minimum spend of $4,000 in the first three months to redeem the sign-up reward.

Paying off the credit card balance before interest has a chance to accrue is essential for those considering cash-back bonuses as part of this plan. If that level of spending doesn't derail other financial obligations, such as a car loan payment, it could be a way to put a bigger dent in your student loan balance.

[Read: Understanding the Statute of Limitations on Student Loans.]

Taking advantage of introductory offers. Credit card interest rates are reaching historic levels, and not in a good way. The average interest rate for newly issued credit card accounts is more than 17 percent, according to the latest report by Bankrate. This doesn't bode well for those hoping to save money on student loans by moving the balances to a card with a lower rate.

For those who qualify, there are still credit cards that offer interest-free introductory offers that can be used for purchases or balance transfers. The latter option can pave the way for student loans to be repaid without interest, but there's a catch. In most cases, card issuers charge a fee to process a transfer. The fee is a percentage of the balance transferred and can be as high as 5 percent in some cases. If you transfer a $35,000 balance, you could find yourself paying more than $1,700 in fees.

While some credit cards will accommodate a student loan balance transfer, others may not allow a direct transaction. That creates the extra step of drawing the funds in the form of a convenience check that can be used to pay off the student loan.

After all of that, there's still the deadline for the interest-free repayment. If you don't repay the entire transferred balance before the clock runs out on the introductory offer, the standard interest rate can be applied to the remaining balance and even retroactively with some credit cards.

Skirting bankruptcy restrictions. Looking for ways to circumnavigate existing laws that apply to student loan debt is a dangerous game and an ill-advised way to resolve repayment issues. There are several affordable repayment options, such as income-driven repayment plans, available through the Department of Education. Nonprofit counseling resources are another option for understanding your choices.

Even so, you may feel tempted to sneak student loan debt into personal bankruptcy with the hopes of having your debt discharged.

[Read: Debunking the Student Loan Bankruptcy Myth.]

If you use credit cards as a vehicle to mask your student loan debt and include it in bankruptcy, it could backfire. Any creditor can challenge all or part of a debt that is included in your bankruptcy claim if it feels that the circumstances for filing are based on an intent to commit fraud, or if the debt is related to purchases of luxury goods.

If you move all of your remaining student loan debt to a credit card and file for bankruptcy afterward, it may capture the attention of your credit card issuer and lead it to dispute the balance based on suspicion of fraud. If the bankruptcy court rules in favor of the issuer, you could find yourself having to repay the balance along with interest and legal fees.

The Student Loan Ranger recommends that you exercise caution when considering a credit card to make installment payments or pay off student loan balances. Explore the alternatives while learning about the advantages and disadvantages of each.



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