How to Use Bitcoin to Repay Student Loans

In recent years, cryptocurrencies, like Bitcoin, have become increasingly popular. Cryptocurrencies represent digital money that exists only in electronic form. These currencies can’t be used universally, and aren't backed by the federal government, making their price fluctuate often. As of December 3, 2021, one bitcoin costs more than $53,400.

However, even though cryptocurrencies represent a new asset class, they’re used for various purposes — including as a way to tackle student loan debt. If you’re interested in using Bitcoin to pay off your student loans, here’s what you need to know.

How to use Bitcoin to pay back student loans

You have two options if you want to use bitcoin to pay back student loans. You can either sell your bitcoin and use the proceeds to repay your loans, or get a decentralized finance (DeFi) loan based on your crypto assets. This guide will focus on the latter.

DeFi loans to repay student loans

There are a number of DeFi apps designed to loan you money based on your cryptocurrency holdings — and even non-fungible tokens (NFTs). Rather than selling these assets and triggering a taxable event, you instead use them as collateral to get a loan.

How it works

Through a DeFi platform, you’ll use your cryptocurrency assets as collateral to obtain a loan. Then, you’ll use the DeFi loan proceeds to pay off your existing student loans.

The terms for paying off the new DeFi loan might be more flexible, allowing you to make payments on your own schedule. Some of these loans also have much lower interest rates. This is one way for you to pay off your student debt without selling crypto assets that could be worth much more in the future.

General requirements

Your DeFi lender will likely require you to maintain a value of at least 50% of the loan. For example, if you want $26,000 to pay off your student loans, your crypto assets would need to be worth at least $13,000.

Additionally, many DeFi apps are built on the Ethereum blockchain, so you’ll need to either convert your bitcoin to ether (triggering a taxable event) or use what’s known as “wrapped bitcoin” to manage the transaction.

Caveats

Realize, though, that there are some drawbacks to DeFi loans like this. Since cryptocurrency prices are so volatile, your loan could come due if the value of your assets drops below the loan-to-value threshold.

You’d either need to put more assets in as collateral, or pay off the loan. If you fail to do so, a smart contract protocol could automatically liquidate and claim your cryptocurrency to pay the loan.

Additionally, using this method is essentially refinancing your student loans. Once you pay off your federal student loans, you’ll lose access to federal benefits, like income-driven repayment and loan forgiveness, including Public Service Loan Forgiveness. But you’ll still have a DeFi loan to pay off.

Carefully consider whether this is the right move for you before getting a DeFi loan. These loans can be flexible and inexpensive, but they come with risks.

Pros and cons of using Bitcoin to pay down student loans

Before deciding to turn in your bitcoin or other cryptocurrency to pay down student loans, it’s important to consider the advantages and drawbacks. Selling bitcoin seems like an easy way to pay off the debt faster.

After all, for many borrowers, selling one bitcoin would cover all of their student loans — probably with a little extra cash left over. On the other hand, one of the biggest downsides is the tax consequence.

Pros

• Pay off your debt faster. By selling your bitcoin and using the proceeds to pay off your student loans, you could be out of debt much faster, saving you money on interest in the long run.
• Capture gains. If you’ve had bitcoin for a while, and you’re worried about a crash, selling some of your tokens to pay off student loans can allow you to capture gains while getting rid of debt.
• Increased flexibility. Even if you don’t cash out your bitcoin to pay off student loans, you can use them as collateral for a more flexible, DeFi loan. This could result in a lower interest rate and let you capture future gains while creating a new loan with more flexible terms.

Cons

• Potentially miss out on big gains. If the price of Bitcoin goes even higher, you could miss out on those gains if you sell to pay off student loan debt.
• Taxable event. Selling your bitcoin is a taxable event. You must set aside money for taxes if you use bitcoin to pay off student loans.
• Liquidation with DeFi loans. Even if you use your bitcoin as collateral, you run the risk of losing some of it. If the price drops dramatically, you might no longer meet the required threshold for the loan and it could become due.

Possible tax implications

Your potential tax bill represents one of the biggest issues with selling bitcoin to pay off student loans. The IRS treats cryptocurrency like property for tax purposes, similar to how it views stocks.

If you’ve held onto your bitcoin for longer than a year before selling, you can claim a lower, more favorable long-term capital gains rate. However, if you’ve had your bitcoin for less than a year before selling it, you’re stuck paying taxes at your regular tax rate.

Example tax estimate for selling bitcoin

When calculating your taxes, start with the basis of your bitcoin, which is the amount of money you paid for it. Let’s say you bought one bitcoin for $900 in early 2017. Now, you want to sell half of it to pay off $20,000 in student loans. You sell that half for $26,700.

Your total gain is $25,800. Since it’s a long-term gain, though, you have a favorable rate. Depending on your current income and tax bracket, you might pay 0%, 15% or 20% in taxes on that gain.

What if you bought Bitcoin earlier in 2021, when the price was $32,000? Maybe you bought half a bitcoin for $16,000. Now, if you sell that entire half for $26,700, you have a gain of $10,700. It’s a smaller gain, but you’ll pay taxes on it at your regular income tax rate, based on your tax bracket. Depending on your situation, that could actually mean a bigger tax bill.

Before selling bitcoin or other cryptocurrency to pay off your student loans, talk to a tax professional about the consequences. Run the numbers to determine whether it makes sense for you to sell blockchain assets to pay down student loans.

Conclusion

With the value of bitcoin so high, it’s tempting to use blockchain-based currencies, like cryptocurrency, to pay off student loans. You could potentially be debt-free faster. However, selling your bitcoin could result in a hefty tax bill. Plus, you might miss out if the price of bitcoin increases over time.

DeFi loans can be more flexible and less expensive, but they have their own risks and the price volatility of cryptocurrencies could work against you.

If you won’t use federal benefits, want to potentially lower your interest rate, and pay off your student loan debt faster, refinancing with a student loan lender might make sense. Consider comparing traditional student loan refinance lenders to reduce your debt without touching your bitcoin or other crypto assets.