Repaying Student Loans Part 3 of 3

Part 3 of our Student Loan series, part one Student Loans Jackpot and part two Applying For Student Loans should be read first before reading on.

The cap and gown fit nicely, and everyone wants to shake your hand.  You go to a ceremony and listen to the same 20 clichéd metaphors that every graduate endures, and then suddenly you’re pushed out of your cozy confines of post-secondary education and into the not-so-warm embrace of the working world – now what?

At the end of the day someone has to pay the piper, as the saying goes, and in this case the piper is pretty adamant that their bill will be paid!  Student loan debt is notoriously difficult to squirm your way out of, and even if you declare most types of bankruptcy it will still follow you around (this is to prevent the obvious scenario of every student who has debt simply declaring bankruptcy when they step into “the real world”).  If you manage to not pay your student loans (default) your credit score will take a massive hit.  This might not mean much to you now, but a low credit score means banks might not lend you money to buy a car or a house, and if they do they will make you pay crazy high rates of interest.  Let’s just say “dine-and-dashing” is not an option here.

When you finish your studies you will have to make a few decisions about how you will go about repaying that chunk of money that you borrowed.  To put it in terms that the average 18-year old might understand: This is the Sunday morning after the party of the year buddy.  Actually, it’s not all that bad.  Basically, after you leave your post-secondary education you have to make the following decisions:

1) When do you want to start paying your loans back?

2) What system will you use to make your loan payment every month?

3) What type of interest rate will you choose to apply to your loan(s)?

4) What length of time would you like to pay your loans over and subsequently how much will you pay every month.

Depending on which province you live in, different rules apply (see our last article for how each province administers its financial aid).  When you come to pay your loans back, almost all of the student loans include some sort of “grace period” to let you get on your feet and find work.  For the Canada student loans, this grace period means that you don’t have to make any payments for six months, but interest on the money you borrowed will begin to accumulate.  The provincial rules vary a little, but the same principal applies.  You don’t have to take advantage of the grace period, it is just an option.

There are a variety of ways you can choose to pay your student loan after you leave school.  It is important to note that it is your responsibility to set up a program to repay the money that you borrowed.  Usually the student loan administrators will give you notice either by phone or email, but it is still up to you to follow their directions and set up your payment plan.  If you fail to do this, payments will begin to automatically be taken out of the account that you had original loan deposited into.  If there is no money in that account please re-read this section and pay attention to the term “default” (do not pass go, do not collect $200).  While you can choose to write a check every month, the vast majority of young people I know today take advantage of the efficient nature of an automatic payment plan where their loan payment is taken out of their bank account every month without them doing anything.  This eliminates a lot of paperwork, and the possibility of forgetting about the manual process of writing a cheque.

Welcome to the world of interest rates.  Interest rates are powerful forces of nature that can make you rich if you make them work for you, or can cripple you if you fail to harness their power.  If you’re thinking this sounds like some sort of black magic from Game of Thrones, then actually you aren’t far off.  Most Canadians understand science fiction than how interest rates work!  As far as your Canada student loans are concerned, there is only once choice you have to make:

Option 1: The amount you borrowed will be subject to a variable interest rate of prime + 2.5%

Option 2: The amount you borrowed will be subject to a fixed interest rate of prime + 5%

Your provincial student loans will likely have a similar option, but again, the detail vary depending upon where you borrowed the money.

I know many of you probably got nervous while reading that “banker’s speak”, but it’s pretty straightforward.  The “prime” reference is referring to the prime interest rate that the Bank of Canada sets every three months.  This is sort of the baseline for any loan you take out.  The terms “variable” and “fixed” refer to whether or not you want to lock in your interest rate at a specific number.  Since the prime rate can move back and forth, you can choose to lock in your loan at the current rate plus 5% for the life of your loan and you will know exactly how much you will pay every month (it won’t ever change).  If you choose the variable rate, it will “float” with the prime rate and always stay 2.5% above what it currently is.  In other words, you are paying a premium for the security of locking in.  Canadians are a weird people in how much we treasure the security of fixed interest rates.  In choosing between these two options you will likely hear numerous smart people give you completely different pieces of advice.  For what it’s worth, in broad studies that have been done that looked at mortgage loans, using variable rates saves people money about 90% of the time.  That being said, interest rates are extremely low right now (2012) and some people would suggest this means you should lock in before they rise.  The truth is that no one has any idea what the prime interest rate will do more than two years from now.  If they do, they are going to keep it secret and make a lot of profit off of it.  For my money, the spread of 2.5% is just too wide, and I am fairly certain the vast majority of students would be better off with a “floating” or variable rate, but there is always the chance that interest rates could quickly rise and make that opinion look dumb.  Even if you don’t take the path I suggested, the silver lining is that you could flip a coin and be just as smart as the “experts” that will tell you one rate is decisively better than the other.

The final decision you have to make in regards to your student loans is how you what to organize your payment schedule.  The default option that most students choose is a paying back the loan over a 10 year time frame (which includes the grace period).  If you want to be out of debt faster, you can set the time frame for a shorter time period, but then obviously you will have to pay more each month.  An important consideration is that you can choose to raise your monthly payment at any point, or make a lump-sum payment whenever you want as well.  Given that fact, I would suggest setting up a basic 10 year plan and then just making larger payments if you decide you want to at any point.  There is no penalty for that.  Remember that if your loan was from some provinces you will actually be paying off the provincial student loan and the Canada student loan separately, so you’ll have to make two sets of arrangements.

Repayment Assistance Plan

If you are having trouble paying your student loans and feel like you’re about to drown, there are some life-preserving options that are open to you.  Starting in 2009 the federal government started a program called the Repayment Assistance Plan (RAP).  In case you didn’t notice, a government program known by the acronym RAP is their way of trying to stay “hip” and connect with the youth of today.  If you apply for this program, you may be eligible for help with interest relief and debt reduction depending on what your income levels and employment status are.  Similar help exists if you have a permanent disability.  At any point borrowers of student loans can look at revising their terms of their loan and there may be some help available.  I would recommend applying before your financial situation hits a crisis point so that there will be time to stave off Armageddon.

Paying Student Loan Interest Can Make Me Money?

One cool thing about student loans that you probably don’t care about now, but you will in a few years is the fact that the interest you pay on them is eligible for a federal tax credit, and probably a provincial tax credit as well.  This means that because you paid interest on your student loans during the year, both your provincial and federal governments will give you money back on your tax refund.  See our article on student tax refunds for more information.

We hope you enjoyed our student loan series!

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