If you have student debt, I know it is really hard to even think about it, but reading this article means you are already taking the first step to being DEBT FREE, by educating yourself on your student loans. 🙂 In this article, I will show you two main student loan repayment strategies and the best strategy for you depends on your unique situation.
Strategy #1. Pay off your Student Loan ASAP:
The first strategy is to pay your loan as fast as possible in 5 years or less. For OSAP student loans, the repayment period is usually a max of 10 years. So if your loan is $30,000, you’ll be paying monthly payments of $500 (30,000/5 years/12 months) for 5 years. But, this does not include interest which has an annual average rate of 6%, but accumulates daily (See my previous article on how interest on OSAP is calculated).
Benefits:
- The major benefit from this strategy is that it reduces the overall interest you have to pay. This interest is a significant burden especially over 10 years. That’s why by paying off your loan faster you can REDUCE the overall amount of interest you will pay.
- Another benefit of this strategy is that it gives you the FLEXIBILITY to be debt free within 5 years. If you are planning to move, switch jobs, buy a house, or raise a family, it may be difficult to do these things if you still have student debt weighing you down. That’s why by being debt-free gives your more flexibility to do the things you want.
- In addition, this strategy has a HIGH success rate. One of the main reason why people are not able to pay their debt, is that they end up using any disposable income to buy a house/clothes/vacation etc instead of paying off their loans. By automatically allocating a fixed amount of money your student loans every month, you are no longer tempted to use it for other things, reducing the margin of error.
Drawbacks:
- A con of this strategy is that it is not for everyone. If you have an extremely large loan and not enough disposable income to pay it off within 5 or less years, you may want to choose strategy #2.
- Another con to this strategy is that you will have less money on hand. Since you are putting down more money per month to pay off your loan, you will have much money to invest or use during an emergency financial situation.
- Lastly, there you won’t be able to take advantage of the tax credit from the interest on your provincial/federal student loans. A tax credit reimburses you for some of the tax you paid to the government. If you get rid of your student loans and pay less interest, you will also receive less of a tax credit.
Overall:
Paying off your student loans ASAP is a really simple and easy-to-implement strategy with a high success rate. However, some of you don’t have the luxury of paying off the loan in a shorter amount of time, which is why the second strategy will appeal to you more.
Strategy #2: Extend your payments and Invest:
The second student loan repayment strategy is to extend your loan payments as long as possible and instead INVEST your money. Normally, you have to payback the loan within 10 years, but depending on your circumstances, you can extend this to 14+ years.
Benefits:
- By reducing your minimum payments, you will have more money to put into your savings and investments. A reason you may want to invest your money, instead of paying off your student loans is because the return on your investments MIGHT be HIGHER than the interest on your student loans.
- Example: If your student loans have an average interest of 6%, and your investments have an average return of 8%, than you just made 2% of extra money! 2% may not seem a lot, but remember that this 2% of extra returns is over 10 years and compounds on your investments.
Drawbacks:
- However, if your investments perform less than 6%, than you would have been better off just paying your loan. So is it possible or likely that you will obtain a return higher than 6%? Well, if you read my previous article average market return over the long-term are approximately 7%. There are ways you can achieve higher market returns but you would have to take riskier investments. Either way, by extending your payment period to 10+ years, you have the capacity to invest in more risky investments to obtain a higher return. If we enter into a recession, in Y5, you still have 5+ years to wait until the market recovers.
- Another drawback is that you MUST actually save and invest your money. You can’t suddenly decided to go on a $5000+ vacation trip using your savings just because you feel you have money. If spend your savings it defeats the purpose of extending your payments.
- Lastly, there is a lack of flexibility if you have student debt generating interest. It may be difficult to change jobs or move while you have this student debt chaining you down.
Overall:
Extending your payments and investing may be your only option if you are unable to pay your loan faster, but you have the opportunity to make more money if you can achieve a higher return from your investments than interest on your student loans. However, this strategy will require a lot more patience, expertise, and has a lower rate of success than Strategy #1.
Comparing Strategy #1 and Strategy #2:
Lets say you have $100,000 of student loans and $20,000 of annual disposable income. **Assume that Student Loan Interest Rate is 6%, and the average return is 7%)**
If you choose strategy #1, you will allocate all $20,000 of your income in pay off your student loan. It is only after you have completely paid off your loan, that you will allocate the $20,000 into your investments.Â
If you choose strategy #2, you can allocate $15,000 every year to pay off your loan in 10 years. The remainder $5,000 (15,000-10,000) will be invested in the stock market,
The Best Student Loan Repayment Strategy
It is up to you to choose the best student loan repayment strategy for you! Be realistic! If you don’t think you can afford to pay the loan in a shorter amount of time, it’s perfectly fine to extend your payments.
