One thing we want to emphasize before diving into this post is that this strategy is for people who are financially responsible and pay off their credit card in full each month. The last thing you want to do is move a loan from a low-interest loan to a high-interest one.
This strategy also doesn't make sense if you're not working towards hitting minimum spend. If you have a new credit card with a signup bonus, you usually have to spend a large sum within three months. Why not pay off loans and get "rewarded" for it?
Gift of College
Gift of College is a service that lets you purchase gift cards to pay off student loans. You can pay off your student loans or invest in a 529 plan to help prepare for college for yourself or someone else. Before you buy gift cards, be sure to call your loan servicer works with Gift of College.
To buy the gift cards, you can buy them in-person or online. If you buy a gift card worth more than $100, there is a service fee of $5.95. The maximum amount you can purchase online is $500.
If you purchase the gift cards online, the maximum amount you can buy is $200. You can find Gift of College gift cards at retailers like Target, Best Buy, and Toys R Us. As a reminder, since you are purchasing a gift card with a credit card, the cashier might say no. YMMV.
Something else to consider is that once you apply the gift cards to your account, it might take a few days to reach your servicer. This process can take anywhere from 3 days to 3 weeks. Be sure leave some buffer room in case it takes a long time to process.
Buying gift cards in-person
If you're purchasing gift cards in-person, then it makes sense to puchase the maximum amount, $500, since you're paying the $5.95 service fee anyway.
When you purchase $500 in gift cards, you're paying 1.2% in fees. If you use a credit card that earns 2% cash back, like the Citi Double Cash card, your net return on spend is 0.8%.
Another way to think of it is that you're spending $6 to get $10 in cash back, which is net $4. This doesn't seem like it's worth the effort.
However, if you were working towards hitting the minimum spend requirement on a credit card, things get more interesting.
For example, we talked about the Amex Gold Delta card yesterday that earns 60,000 after you spend $3,000 within the first three months. The net return on spend is 22.8%. You're spending $6 to get $120, which nets $114.
You might be wondering if getting a new credit card will hurt your credit score. Contrary to popular belief, the more credit cards you have, the better it is for your score — as long as you pay your balance every month. Watch this video to learn how to improve your credit score long-term.
With the Amex Gold Delta card, there is a $95 annual fee, but it's waived the first year. The good thing about the card is that there is a downgrade path. After the first year, you can product change the card to a no annual fee Blue Delta card if you're not getting positive expected value.
Buying gift cards online
The main difference with buying gift cards online is that the maximum amount you can purchase in one transaction is $200, and you still have to pay the $5.95 fee.
With the Citi Double Cash example, it doesn't make sense to purchase gift cards online because you're losing 1%.
If you're trying to hit minimum spend, it's a lot more reasonable. With the Amex Gold Delta card, you're getting a 24% return on spending; you're netting $42 on one $200 gift card.
At the end of the day, it depends on your situation and what you prioritize. I think the online route is optimal because you save time by not having to look for gift cards in-person.
In 2015, the average student loan debt was $30,000.
Assuming you're using a new credit card like the Gold Delta card to hit the minimum spend requirement, you're getting a 24% return on spending by paying off your student loans. At $30,000, you're spending $893 on fees to net $6,308 in value.