Dear Dr. Don,
Currently, I have a $22,000 outstanding student loan with a 6.6 percent interest rate. I need advice on how I should repay the loan. In the past, I’ve paid more than $2,000 in interest each year. Do you think it is best to pay off the loan or sign up for credit cards to pay it off? That would mean I’d have to apply for several credit cards, hopefully at low rates of interest. I also worry that if I pay off the student loan, then I might not have any money set aside for a rainy day. Please tell me what you think is best. How much is tax deductible if I continue to make payments each month, as I am doing right now? What is the best way to do this to maximize any potential financial benefits?

— Muy Machinations

Dear Muy,
Ignoring any payment of principal over the year, your annual interest expense on a $22,000 loan balance at 6.6 percent is $1,452. Unless you’re making interest-only payments, your interest expense for the coming year should be even less than that because you’re paying down principal over time.

Managing a collection of credit cards to reduce your interest expense has its own set of additional risks. You’re not transferring credit card balances from another credit card, so you have to find a card that has a teaser rate on a cash advance. Multiple credit card applications over a short period of time will negatively impact your credit score, making it even harder to qualify for that great credit card offer. You also give up any of the loan payment options available with your student loans, including any tax deductibility of the interest payments.

I understand students and graduates complaining about the high interest rates associated with student loans. Comparing student loan rates to mortgage rates isn’t a fair comparison, however, because a mortgage is secured by the house as collateral. You’ve borrowing money unsecured at a fixed 6.6 percent. That’s not a bad deal. Bankrate’s latest national average for a fixed-rate credit card is 13.02 percent. It’s 15.15 percent for variable-rate credit cards. The cards are unsecured debt, too.

In an ideal world, you could use your emergency fund to pay down your student loan, and then replenish the fund over time and come out ahead. But to do that means you’ve lost the potential protection the fund offers.

The value of a tax deduction depends on your income level and marginal federal income tax bracket. Don’t let taxes be the guiding force or the tail wagging the dog here. I’d argue that you should be making additional principal payments each month to chip away at the outstanding loan balance, and set a target date for paying off the debt. Do that, and I’ll give you an A for the day!

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