THE BASICS – WHAT IS DEBT & INTEREST?
Let’s start with the basics of what is debt and interest. Debt is money that you are borrowing from someone else because you may not have enough money. Unless you are borrowing from your “kind” parents, there is no incentive to let someone borrow your money without a cost. In fact, there is a risk of lending money because the borrower might “default” or never pay back your money.
That’s why interest exists! Interest justifies the inconvenience of lending out money and risks of being unable to re-collect your money. (that why interest is usually higher with people with bad credit ratings).
INTEREST RATE ON OSAP
The basic formula for interest:
Now the interest rate on your OSAP loans are split into 2 sections: The Federal & Provincial portion of your student loan. The Federal portion consists of 70% and the Provincial portion is 30% of your student loan.
Interest on Federal Student Loans = Prime Rate + 2.5% = (3.95+2.50) = 6.45
Interest on Provincial (Ontario) Student Loans = Prime Rate + 1.0% = (3.95%+1.0%) = 4.00%
Average Interest = (6.45*70%) + (4.00%*30%) = 5.70%
But what is the PRIME RATE?
So currently prime rate is 3.95%.
Prime Rate is a rate set by the Bank of Canada and it is used as a base to calculate variable/floating interest rates. Floating rates are rates that can change. This chart shows the prime rate over time, starting in 1935. The prime rate fluctuates depending on the health of the economy. During recessions (bad economy) the prime rate is usually lower. This is because in times of recessions, the banks want to encourage people to spend to improve the economy, so they give out loans at a lower price or prime rate. However, in times of booms (good economy), the prime rate is usually higher, because the banks know that people are able to afford to borrow at a higher prime rate.
This is what your student loan is based on. Although today the prime rate is 3.95%, depending on how well or bad the economy does, your interest rate can change. That’s why it is called a floating or variable rate because it can potentially change over time.
DAILY INTEREST ON OSAP
If the interest on OSAP was annual, it would be calculated by: Total Loan * Interest Rate
However, this is the formula if it were an annual interest rate. Interest on OSAP is based on a DAILY basis, which means you get charged interest everyday of the year.
Therefore, to calculate your daily interest rate on OSAP the formula is:
This is good and bad. It is good because if you make payments within the year you can reduce the amount of daily interest. However, if you aren’t making any payments, the daily interest gets added back to your total loan, and increases your interest payments for every day that passes.
CONCLUSION
This is ultimately how the OSAP on your loan is calculated. I hope you gained a better understanding on how your OSAP loans actually work, but there are still so many unanswered questions like: What is the best strategy to pay off my student loans, or should I invest or pay off debt, or what are tax credits on student loans!? If you are interested, I am creating a tool to help you to create the best strategy to tackle your student loans. If you want to be notified once I release it sign-up here:
