The Big Question: Pay Off Student Loans or Invest?
If you’re like millions of Canadians with student loan debt, you’re probably looking forward to the day it's all paid off. With some extra money in your monthly budget, you may be torn between increasing your monthly loan payment or investing that money instead. Here we’ll take a look at some things to consider and offer a few tips that will help you make the best decision for your financial future.
Student loan debt can be a huge financial burden for those who pursued a better life through education. According to?reviewlution.ca, the average student borrower had over $26,000 in loans in 2015. With the current inflation rate and high cost of living many borrowers are feeling the pressure and are interested in ways to improve their financial wellness. Whether you are new to the financial world or an experienced investor, choosing how to allocate your money is often a difficult decision that involves many factors.
NOTE:?There is currently a suspension of interest on Canadian student loans until March 31st, 2023. This provides an excellent opportunity to build or expand upon your financial portfolio while there is no interest being charged. Many borrowers are choosing to take advantage by investing, while others are opting to pay off as much of their principal balance as possible, resulting in lower interest payments when they resume.
Understanding your Loan
The first step to making an informed decision is to understand your particular loan. Many borrowers have a combination of federal and provincial student loans, which can vary depending on the province in which you borrowed. For example, federal loans are offered at both fixed and variable interest rates. A fixed federal loan has a set interest rate that does not change throughout your loan repayment period. Variable rates are often lower in the short term but fluctuate based on Canada’s prime rate. This means the amount of interest you pay could significantly change throughout the 10+ years you are making payments. As of November 2022, Canada’s prime rate was 5.95%, up from a rate of 2.45% at the beginning of the year. Understanding how these rates influence your monthly payment and the principal balance is important to make the right choice.
Using the numbers above, this?calculator?was used to estimate a monthly payment. For a loan balance of $25,000 in a repayment period of 120 months (10 years), the following would apply:
For a fixed rate loan: 2% + prime or a total interest rate of 4.45%. The estimated monthly payment would be around $283.?For a variable rate loan: Current prime rate of 5.95%. The estimated monthly payment would be around $302.
As you can see, the variable rate was originally the better value. However, as interest rates have increased the monthly payment is now higher on a variable loan. Fluctuating monthly payments are something to consider when choosing your loan type, especially when interest rates are trending upward. For those planning to aggressively pay off their balance in the short term, a variable interest rate may provide a higher value compared to fixed rates being offered. For someone who plans to make minimum payments throughout the duration of their repayment period, fixed-rate interest loans are often the better choice.
In general, fixed-rate loans are considered the safer option, protecting the borrower from wild fluctuations in the interest rate due to financial instability.
Understanding the provincial portion of your loan is also important. Each province governs its student loan programs individually and certain provinces (Manitoba, Nova Scotia, Prince Edward Island, and British Columbia) offer a 0% interest rate. Certain provinces offer extended grace periods or no interest on loans taken out after a certain date. Visit your province’s student loan website for information on these offers and more.
Furthermore, be sure to explore any student loan forgiveness available to you. The best way to pay off debt, after all, is to have it forgiven. For example, starting in 2023 the Canadian government is offering up to $30,000, or $60,000 in loan forgiveness for nurses and doctors working in rural communities. Additionally, certain provincial loans may be eligible for relief. British Columbia currently offers provincial student loan relief for those working with ‘underserved populations. Do your research and see if you qualify for any of these programs - it could save you tens of thousands of dollars.
Personal Goals
What is your principal balance? The amount you borrowed may influence how aggressive you want to be in paying it off. A borrower with $5,000 in outstanding balance may want to be more aggressive than someone with $50,000, who may take a different approach to repayment and explore other options. What is your repayment structure? Many student loans default to a repayment term of 10 years and monthly payments are calculated based on this time frame. If you haven’t already, contact your loan provider to explore all of the repayment options you have to choose from, as some may fit your lifestyle better than others.
Another thing to consider is that student loan payments can provide a tax credit. According to?Canada.ca, “You receive a 15% tax credit on the interest you pay on your government student loans each year. This credit applies to interest payments you make on both your federal and provincial or territorial student loans”. Take advantage of this to keep more money in your pocket come tax season.
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Market Trends
The stock market is ever-changing and following current trends can be difficult. 2020 saw itself as a tumultuous year due to the economic restrictions related to COVID, causing uncertainty and market sell-offs as investors cashed out their portfolios. Since then, the market as a whole has made a strong comeback as investors regain confidence lost during a shutdown economy. The workforce is continuing to return to work as additional jobs are being created, providing a strong indication the stock market may continue to rebound and grow from pre-COVID levels. This, along with the freeze on federal student loan interest, indicates this is an excellent time to begin building a strong investment portfolio.
An important thing to consider is access to your funds. When deciding whether to pay off your loan or invest, keep in mind that the majority of your stock market investments are ‘liquid’ - meaning you can easily convert them back and forth into CAD if need be. When you make a payment on your outstanding loan, your balance decreases but you no longer have access to that money. Investments - although riskier than a savings account - provide an emergency nest egg that can come in handy during times of financial stress. Experts recommend you have savings equal to at least 2-3 months of your monthly expenses. For borrowers with less than this amount in accessible cash, it may make more sense to stick with the minimum payment on your loan while you establish an investment portfolio.
Choosing an Investment
Once you’ve decided to invest, what do you choose? Companies like Robinhood and Wealthsimple have brought trading to the mainstream. Their low cost and low barriers have attracted many investors to these platforms in recent years, especially among the younger demographic. However, for those without a financial planner or background in investing the world of stocks, bonds, ETFs, and mutual funds can be a jungle. Below are a few examples of financial products you may consider adding to your portfolio:
Investing in US Stocks
Investing in US stocks is a great way to diversify your portfolio and tap into a huge financial market. In order to purchase American stocks you will need USD. Take the guesswork out of?currency exchange with Remitbee.?Remitbee reliably provides high exchange rates and allows you to easily convert Canadian and US dollars between your bank accounts. Completely online, there’s no need to leave your couch!
Talk to a Professional
The best piece of advice we can give is to talk to a professional. Speaking with a financial planner allows you to customize your investment portfolio and get individualized insight from experts who understand the current market climate and trends. Financial advisors help to find products that meet your short and long-term financial goals while considering the level of risk you are comfortable taking.
Conclusion
In conclusion, now is an excellent time for those looking to start investing, or increase the size of their portfolio. Student loan repayment is a long-term commitment and those with a significant amount of debt should take advantage of the current interest rate freeze to invest. Not only does a large, market-tracking index fund allow you to grow your investment, it provides a safety net in the event your financial situation changes. For borrowers with a lower principal balance, take advantage of this time to aggressively pay your balance off. With a current interest rate of 0%, all of your payment goes toward your principal loan amount bringing you ever closer to the coveted balance of zero.
Written by Skyler Maurer