There’s a lot of debt going on out there in the world. It’s so common it’s become a way of life. At the start of 2016 Canadians had an average consumer debt of $21,384 and the average student debt in 2015 was $26,819. That’s crazy huge and even worse, that number is rising. Today we’re going to deep dive into understanding your debt so you can better appreciate what you’re paying for. This will be a two-part post – today covering student debt and next week covering mortgages, personal lines of credit and credit card debt. Today I’m largely referring to Canadian provincial and federal loans. Private student loans will be covered under personal lines of credit next week.
In the United States 60% of college grads have student loan debt. I get it, school is freaking expensive, especially if you’re going to school in the U.S. or are an international student. Most people who take on student loans need to, or a post-secondary education would be out of the cards. It’s kind of a double edged sword, where if you take some time after graduating high school and instead work to save money for school, you’ll likely be earning close to minimum wage – thereby it taking you longer to accumulate money for school than perhaps getting a loan and hopefully landing a higher paying job after graduating from university.
Awesome student loan fact: Barack and Michelle Obama racked up $120,000 of student debt which they didn’t completely repay until he was elected to the Senate in 2004 – 4 years before he become the President of the United States!
All The Parts
Let’s look into the different parts that work together to determine how much you’ll pay on your loan.
- Balance – This is the dollar amount you borrowed. Also known as the principal.
- Interest, part I – This is the cost of doing business. It’s the percentage of the balance that you have to pay the government/bank for the pleasure of borrowing the money. It can be charged daily, monthly, annually, etc. Interest can start being charged to your loan as soon as you receive it, however in Canada, if you are attending post-secondary full time, your federal and provincial loans remain interest-free until you graduate.
- Interest, part II – Compound Interest – If your loan starts accruing interest while you are in school you need to understand how compound interest works. Let’s use an example: I start school with a $15,000 private loan which starts accruing interest at 3.5% annually the moment I receive the money. After the first year I owe $15,000 X (1 + 3.5/100) = $15,525. After another year I would owe $15,525 X 1.035 = $16,068. The interest amount owed every year is added to the balance and is then charged interest.
- Interest, part III – Your interest can be fixed, meaning it doesn’t change over the life of your loan, or variable, which means that it’ll be the prime rate (currently 2.95% in Canada at the Big Banks) PLUS a fixed percentage amount. For example, prime + 2.5% = 4.95%. The 2.5% addition never changes but the overall interest rate fluctuates with the prime rate.
- Grace Period – Some loans will have a period of time where you do not have to start paying them back. In Canada, federal and provincial loans have a grace period of six months, however, the federal loans will be accruing interest while some provincial loans (Alberta for example) will remain interest free until six months after graduation.
- Repayment term – How long it will take to pay that baby back. This is usually a fixed number of months/years based on the amount you borrowed. For Alberta provincial loans, the repayment term is 9.5 years for loan amounts over $6,001. The repayment term can be extended up to a maximum amount of 14.5 years.
- Monthly Payment – The amount you pay every month. It’s determined by how much you borrow, your repayment terms, and your interest rate, and is initially determined by your lender. However, you can increase your monthly payments or make additional payments at any time. This is true for Canadian federal or provincial loans – if you have a private loan read the fine print.
Now here’s an awesome calculator for you to go forth and calculate how much you’ll pay for the privilege of having your loan.
Slow and Steady?
Let’s state the obvious, if you increase your monthly payment amount you’ll pay off your loan faster. Paying off your loan quickly after you enter the work force is an amazing gift you can give Future-You. Both for you financial and mental health. If you’re fortunate enough to have a job right out of school, the six month grace period after graduation is a great time to start paying your loan pack. You won’t have been charged much (if any) interest, so any money you pay down then is mostly going against the principal.
To pay your loan down more quickly, you could also add extra payments every month. Even if you only have $20 extra dollars, any extra you can contribute will also go against the principle. Less principal = smaller amount charged interest.
Increase your monthly payment. About 30% of loan-taking students pay back their loans within three years. There’s no need to take a longer repayment term if you can afford to pay more now. With my student debt, I made this a game and kept increasing my monthly payments until they were uncomfortable. Like really uncomfortable. It’s stressful if you go too far, but once you pay the money towards your loan, you can’t change your mind and get it back.
What If You Can’t Pay
If you can’t make the minimum payments on your loan there are still options for you.
The first is to apply for repayment assistance through the federal government. This needs to be done before shit hits the fan, i.e. before you miss a payment. After 90 days of late or non-payment your access to this program is gone. This program is for grads who are without work or are making very little income. This assistance can be interest forgiveness, further reduced monthly payments or even some of the payments against the principal waived. You can use this calculator to see if you qualify for this program.
Your federal loan will be in default if you haven’t made payments for 270 days. It’ll then go to the Canada Revenue Agency and be subject to collections and negatively impact your credit score. The CRA is one powerful government agency and they can claim any income tax returns you may earn to go towards the loan or even garnish your wages. All the while the interest will be building on your unpaid loan. If this happens you can rehabilitate your loan by arranging a payment schedule with the CRA, paying back all interest owing and then make two monthly payments (according to your new CRA-approved payment schedule).
Consolidation is a word that’s thrown around a lot when talking about student loan repayment. However, in Canada, unless you have a private loan, this is not something you need to worry about. Consolidation means that if you have multiple loans (and multiple monthly payments), you can roll them into one loan (sometimes with a more favorable interest rate) and only make one monthly payment. In Newfoundland, New Brunswick, Ontario and Saskatchewan your federal and provincial loans are automatically consolidated. In the Territories and Quebec you can only apply for one type of loan (either federal or provincial). Finally, in the remaining provinces you have to pay back both separately.
The B Word – Bankruptcy
If things get really out of hand, filling for personal bankruptcy is an option there are some things you should know. First, it’s the very last thing you should ever consider. Second, your student loans will not be removed from your file until seven years after you’ve graduated (five years in extenuating circumstances). So if you file for bankruptcy after three years that student loan will still be there – waiting for you. Third, filing for bankruptcy will destroy your credit score. You might not think that’s a big deal but with a shitty score you won’t be able to apply for a mortgage, further student loans, rental housing, credit cards and some jobs even perform credit checks. Unless you’ll be living a cash-only existence in a box for the next 10 years, don’t file for bankruptcy. Bouncing back from bankruptcy is a long, difficult road.
The Final Word
The worst thing you can do with your student debt is stick your head in the sand and ignore it. There are lots of options to change the terms and monthly payments of your loan before you miss a payment. After you start missing payments is when your options start to diminish. If you’re confused or have questions, the contact information for all the provincial and federal loan administrators can be found here and here. They’re happy to help so you can put your loans behind you and move on with your life.