Friday, 17 May 2013

Paying Off Student Debt vs. Investing

This topic is close to my heart, because it is an issue I am currently struggling with. After much number crunching, I think it ultimately comes down to what decision are you most comfortable with making.

I'm a new graduate with a job on the horizon and a huge student debt after 6 years of post-secondary studies. All of my loans are through OSAP, I have no private student loans.

I have called National Student Loan Service Centre to find out the sizes of the Canada and the Ontario portions of the loan because they have different interest rates and different interest start date. The Canada portion of the student loan has an interest of prime + 2.5% (5.5% right now), and while you don't have to repay during the grace period, the interest accumulation has already started. The Ontario portion of the loan has an interest of prime + 1.0% (4% right now) and interest charges start after the 6 month grace period. The good news is any payment you make during the grace period goes straight into your principal, and from my phone call to NSLSC, it goes to the Canada portion. Now, if you're like me and have been benefiting from Ontario Student Opportunity Grant (OSOG) which limits your debt to:

$7,300: the most you will need to pay back for a 2-term academic year.
$10,950: the most you will need to pay back for a 3-term academic year.
Then the Ontario portion of your student debt will be much smaller than the Canada portion.
Now, I know over the long term, a balanced portfolio such as the sample portfolios on Canadian Couch Potato will give return at around 6%. Also, since I'm young, start investing early will get the compounding going and help me tremendously for retirement savings. Using the paying down debt vs investing calculator at:

My break even point is at 5.19% performance of investments, and slightly lower once you factor in the Ontario portion of the loan too. The logical thing to do will be pay back my scheduled payments and invest the rest in a TFSA account. However, I'm not comfortable carrying debt for a long time, and once interest rate goes up, the advantage of investing over paying down debt will be minimized. Also, there is volatility with investment. On the other hand, paying down debt is pretty much a safe bet.

So my decision is to pay down my student debt as much as I can during the grace period, then once the loan enters repayment, use a 2:1 ration of paying off debt to investing.

The take home message: paying down debt and investing are both good options, do the math and make a decision you will be comfortable with. The more important point is DO IT NOW, don't delay. (This was mentioned in the Wealth Barber Returns by David Chilton too. ^^)

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