Pay Off Student Loans Or Save?
After eight years of monthly payments, we finally managed to pay off our student loans last month. Even though it’s a nice feeling to rid ourselves of student debt, we deliberately chose to make the minimum payments for years in order to get the rest of our finances in order.
Very few students can afford to pay for post secondary education without some type of financing in place. Canadian students are graduating with more than $20,000 in student loan debt, which is seriously affecting their financial position as they enter the workforce. Should young people make it a goal to pay off student loans right away, or save money to help improve their finances down the road?
My Experience With Student Loans
My wife and I left University with nearly $60,000 in student loans to repay. I was fortunate enough to have purchased a house when I was 19 (with my parents co-signing), and after University I sold the house for about a $30,000 profit.
Instead of using the proceeds from the house sale to pay off student loans, which would leave us with no savings, I paid off a portion of our debt and used the remainder for a down payment on a new house.
That house doubled in value in the eight years that we owned it. We leveraged an asset, which gave us more potential for financial gains that would not have been possible had just paid off our student loans.
Paying The Minimum
There are plenty of financial pressures facing young people these days. Most new graduates are worried about getting a job in their field, finding a suitable place to live, and making car payments. Paying down your student loans doesn’t need to be an initial priority in your life. Here are a few reasons why:
- The interest rate is low – If you choose the floating rate option the interest rate on your National Student Loan will be prime + 2.5 percent, which currently equals 5.5 percent. Provincial loans are at prime rate which is currently at 3 percent (Newfoundland does not charge interest on student loans)
- Income Tax credit – Any interest paid on your student loan is eligible for a 15 percent Income Tax credit. So if you paid $1,000 in interest over the course of a year, you would get $150 back on your Income Tax paid
- Cash Flow – Why use all of your cash flow to pay off student loans when you could be establishing an emergency fund, saving for a down payment on a house, or paying off higher interest credit card debt?
Pay Off Student Loans On Your Terms
My approach to paying off student loans was to make the minimum monthly payments initially and then increase the payment each year as our finances improved. We each had two loans (Federal and Provincial), and when one of the loans got within striking distance ($2,000 or less), I took some of our savings to pay it off, and then applied the freed up cash-flow to a different loan.
While we could have paid off our student loans faster, I thought that we would be better off investing in our RRSP and TFSA, or paying off our mortgage.
Surprisingly many smart graduates say that their student loans aren’t costing them a lot of money, so they decide to just pay them off early. However a loan this cheap doesn’t need to be paid off more quickly than necessary.
Top priorities for young graduates out of school should be to eliminate any high interest rate debt and then to build up some savings inside a tax free savings account. Doubling, or even tripling your monthly payments in an effort to pay off student loans early is a lot for a young graduate to take on. There’s no need to place an unnecessary burden on yourself with many other priorities to look after.
Do you think the top priority for new graduates should be to pay off student loans, or should they concentrate on building up their savings?
Comments
My student loan is at prime + 0.5, and the interest is tax-deductible, so I’ve been in no hurry to pay it off (I’m allowed two skipped payments a year, and I take them!). The only strong argument I can think of for accelerating student loan payments is to get them off the books if your bank thinks your TDSR is too high when you apply for a mortgage.
I expect to graduate with some type of student loan, unless I can save aggressively in the next few years. However, like you, I’d focus on other financial goals before paying off the student loans, especially since the interest rates will probably be lower than any other debt. Congratulations on paying it off!
I think it all depends on their future goals. For someone who is more entrepreneurialy minded it would be best to eliminate all the dept so you dont need much to live off, but even there it all depends.
So again I would say it all depends.
My student loan interest is about 3% with a big balance, so I’m in no hurry to pay it off. There are more pressing loans outstanding that I’m focusing on right now.
However, one thing that always worries me about student loans is that they can never be forgiven, even through bankruptcy. Scary stuff!
Payer off the loan on your terms seems more plusable but with the new economic normal interest rate hike might make such option risky.
I think the way to do it is to do both. You pay your debts while you save money for the future. How much you pay and save will depend on your expenses and how much you have and will have once you get your job.
The low interest environment makes for an easier payback schedule, like you say. Interest rates are unlikely to rise substantially in the near future, but if a recent grad is anticipating paying off the debt over 7-10 years, potentially higher interest rates should be a consider.
You’ve been lucky that real estate has doubled over the past decade, but young professionals shouldn’t anticipate that trend to continue.
Finally, as you mentioned, TFSA should most likely be maximized before RRSP contributions. The funds in a TFSA are more readily available as an emergency fund and the forgone income taxes will likely be higher in retirement.
I’m gonna go against the grain here and say that I plan on paying off my student loan in the shortest time possible.
I’m paying my loans at a rate of 70% of my net income, leaving me with 30% to live on. for what it’s worth I make a starting engineering salary, so you can do the math yourself.
My plan is to pay off 45,000$ in about 22 months. I have an emergency fund that covers 3 months worth of expenses.
The way I see it, I want to be debt free for the rest of my life after my debt is paid (that includes not having a mortgage). This may sound extreme by most people’s standards, but it make sense to me.