If you’re juggling a car loan and student loans, you might be wondering which debt to prioritize. While it’s important to keep up with minimum payments on all your loans, making extra payments on one of these types may help you save money on interest.
The decision of whether to pay off car or student loans first ultimately depends on your personal financial situation, but the considerations in this guide can help you determine which path is best for you.
Key Points
• Looking at the interest rates and total cost of car loans and student loans can be a helpful way to compare them.
• Prioritizing the loan with the highest interest rate can generally save borrowers the most money.
• Federal student loans are more flexible than car loans, providing income-based repayment options and opportunities for potential loan forgiveness.
• Interest on student loans may be tax deductible. Car loans don’t qualify for a tax deduction.
• Paying off a car loan first can prevent possible repossession of the car in the case of loan default.
Understanding Your Debt Types
First, it’s important to understand the difference between student loans and car loans. Student loans may be federal or private, and they might come with fixed or variable interest rates. They’re unsecured loans, meaning they’re not backed by collateral.
Federal student loans qualify for various benefits and plans that can help lower student loan payments, such as income-driven repayment, as well as programs to temporarily pause payments if needed, like deferment and forbearance. Federal student loans are also eligible for forgiveness programs such as Public Service Loan Forgiveness.
Private student loans don’t have as many benefits as federal loans, but some private lenders will let you modify or postpone payments if you run into financial hardship. You might also explore refinancing student loans to see if you can qualify for a lower interest rate or more favorable terms that might help make your payments more manageable.
Car loans, on the other hand, typically have fixed interest rates and they are secured by your vehicle. If you fall behind on car loan payments, a lender can repossess your car. Car loans commonly have repayment terms of 36 to 84 months.
Unlike student loans, auto loans don’t usually offer much flexibility if you’re having trouble making payments. And car loan payments can be costly — the average car payment in 2024 is $734 a month. By comparison, the average student loan payment is estimated to be about $500 when adjusted for inflation in 2024, according to the Education Data Initiative.
Factors to Consider When Prioritizing Debt
There are several things to think about when deciding whether to pay car or student loans first. Some of the main considerations include your loan’s interest rate, tax implications, and repayment terms.
Interest Rates and Total Costs
It typically makes sense to pay off the loan with the highest cost of borrowing first. This usually means the loan with the highest interest rate. If your student loan has a rate of 5.00%, and your car loan has a rate of 10.00%, paying off the car loan would save you more money in the long run.
Along with the interest rate, consider whether the loan carries any other fees, such as a prepayment penalty. Student loans don’t charge penalties for prepayment, but a car loan might. Compare each loan’s annual percentage rate (APR), as this figure takes both interest and fees into account.
Tax Implications and Deductions
Another factor has to do with tax deductions. The student loan interest deduction allows you to deduct up to $2,500 a year in student loan interest from your taxable income, depending on your modified adjusted gross income (MAGI). At certain income limits, student loan tax deduction phase-outs begin. In 2024, if your MAGI is less than $80,000 a year if you’re a single filer, and $165,000 if you’re married and filing jointly, you can qualify for the full deduction. If you earn between $80,000 and $95,000 ($165,000 and $195,000 if married filing jointly), you can make a partial deduction.
Car loans don’t qualify for a tax deduction on interest unless you are self-employed or a business owner and use the vehicle for business.
Loan Terms and Repayment Periods
Student loans tend to have more flexible repayment terms than car loans. Federal student loan borrowers are eligible for various repayment plans, including the Standard plan, which spans 10 years, and the Extended plan, which is 25 years.
Federal loans are also eligible for income-driven repayment (IDR), which adjusts your monthly payments in accordance with your income and might eventually lead to loan forgiveness. Plus, you may qualify to postpone payments through deferment or forbearance if you go back to school or lose your job.
Car loans don’t qualify for many options. You’ll often choose a repayment term of three to seven years and be expected to pay monthly on your agreed-upon rates and terms. If you can’t make payments, the lender can repossess your vehicle.
Benefits of Paying Off Car Loans First
Paying off a car loan before your student loan can have several advantages, especially since car loans don’t have as much repayment flexibility or offer any tax benefits for vehicles that are strictly for personal use. Here are some reasons to consider prioritizing your car loan over your student loans.
Eliminating Secured Debt
Defaulting on a car loan could lead to losing your car. The sooner you can pay off your secured car loan, the sooner you’ll own your car outright and you won’t have to worry about the possibility of car repossession.
Potential Savings on Interest
Car loans may come with higher interest rates than student loans, so paying off the auto loan first could lead to more savings. Let’s say, for example, that you owe $15,000 on a car loan at a 10.00% rate and a $15,000 student loan at a 5.00% rate, and that both loans have five years left on their repayment.
If you put an extra $100 per month toward your car loan, you’d save $1,232 on interest and get out of debt nearly a year and a half sooner. If you put that extra $100 toward your student loans, you’d also get out of debt about a year and a half sooner but you would save just $574 in interest charges. Our student loan payoff calculator can help you crunch the numbers on your student debt.
You could also consider refinancing your car loan for a better rate to help save on interest. This option might be worth exploring if interest rates are lower now than when you originally took out the loan.
Building Equity in Your Vehicle
The faster you pay down your car loan, the more equity you’ll hold in your vehicle. That means you’ll own more of your car outright, which could come in handy if you ever want to sell it. Plus, you’ll be less likely to end up underwater on your car loan, which can happen when the debt you owe on your vehicle exceeds what the vehicle is worth.
Advantages of Prioritizing Student Loans
Although it often makes sense to prepay a car loan before a student loan, there are certain advantages to paying off student loans first. Here are some scenarios where you could benefit from prepaying your education debt:
• Your student loans have a variable rate: Some private student loans have a variable rate that can increase and make your borrowing costs unpredictable. If you’ve been dealing with a rising variable rate, you may want to pay off those loans as quickly as you can. You might also explore refinancing those loans, which could allow you to switch to a fixed (and potentially lower) interest rate.
• You’re not using income-driven repayment or loan forgiveness: Federal student loans come with a variety of borrower protections, but you may not require any of them for managing your student loan debt. If you don’t need an IDR plan and you aren’t pursuing loan forgiveness, for instance, you might focus on paying off your federal loan debt.
• You’re considering filing for bankruptcy: If you’re in dire financial straits, you might be looking into potentially erasing or restructuring your debts through bankruptcy. Although it’s possible to discharge student loans in bankruptcy, the process is notoriously difficult. It may be easier to discharge a car loan through bankruptcy than a student loan.
Develop a Debt Repayment Strategy
Once you’ve decided which loans to pay off first, it’s important to develop a strategy for repayment. Here are some steps to take.
Create a Budget and Debt Snowball
Start with making a budget so you have a clear sense of your income and expenses. Track your spending, and look for areas where you could cut back. By reducing your spending, you might find room in your budget to direct extra payments toward your debt.
There are debt pay-off strategies that can help. For example, with the debt snowball method, you pay off the loan with the smallest balance first. Then you work on paying off the next smallest loan and so on. The debt avalanche, in contrast, targets the loan with the highest interest rate first, and then the loan with the next highest interest rate, and it can save you the most money in the long run.
The debt snowball may not save you as much money as the debt avalanche, but it can be psychologically rewarding to pay off a debt in full before moving onto the next one.
Seek Additional Income Sources
After budgeting and cutting down on spending, you might explore ways to increase your income. This could mean going for a promotion and raise at work or finding a new job. You could also consider taking on a side hustle, such as driving for a ride-sharing service or doing freelance tutoring.
By setting up additional income streams, you’ll have more cash to put toward your loans and get out of debt faster.
Negotiate with Lenders
If you’re looking to modify payments or adjust your interest rate, try negotiating directly with your lender. Notify the lender that you’re having difficulty repaying the loan and see if they might be willing to work with you. Depending on the type of loan it is, the lender might offer a repayment plan or reduce the loan interest rate, for instance. Although there’s no guarantee of success, it’s worth a try.
The Takeaway
While there’s no one-size-fits-all answer to whether you should pay off a car loan or a student loan first, paying off the loan with the highest interest rate can generally save you the most money. For many borrowers that may be their car loan.
If your student loans have high interest rates, you might consider student loan refinance. If you’re eligible for a lower rate, it may help make your payments more manageable. However, refinancing federal student loans makes them ineligible for federal benefits like income-driven repayment, so you’ll want to keep that in mind as you weigh your options.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
FAQ
Is it better to pay off higher interest debt first?
Paying off high-interest debt first usually makes the most financial sense, since it will save you more money in the long run. However, it’s important to keep up with the minimum payments on all your debts so you don’t end up in delinquency or default.
Can I deduct student loan interest on my taxes?
It depends on your income. The student loan interest deduction lets you deduct the interest you pay on student loans, up to $2,500 a year if your modified adjusted gross income (MAGI) is less than $80,000 for single filers and $165,000 if you’re married and filing jointly. If you earn between $80,000 and $95,000 ($165,000 and $195,000 if married filing jointly), you can make a partial deduction. Anything more than that and you cannot take the student loan interest deduction.
What happens if I default on my car loan or student loans?
A car loan is secured by your vehicle, and if you default on the loan, the lender can repossess your car. Student loans are unsecured, so a lender can’t take your personal property. However, the government can garnish your wages, tax refunds, and Social Security benefits if you default on a federal student loan. Defaulting on private and federal student loans can also damage your credit, and a private lender could potentially take you to court to try to collect the money.
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