Student debt repayment: A case study

It’s not uncommon for recent graduates to enter the working world juggling debt repayments on multiple student loans.

Iman (not her real name), 26, works in the Greater Toronto Area as a part-time communications professional. Her graduate studies left her saddled with $20,175 in Ontario Student Assistance Program (OSAP) debt and a roughly $8,500 student line of credit from her bank.

While OSAP has temporarily waived Iman’s 5.5% interest rate because she’s only working 24 hours per week, her line of credit carries a 4% interest rate.

Beyond minimum payments, Iman’s strategy is to pay off her line of credit in full before shifting her attention to the OSAP loan. She hopes to have her bank loan paid off by September at which point she plans to open a high-interest savings account until she has the full OSAP balance saved up and can pay it off in one shot.

Iman is following a tried-and-true debt repayment model.

“When looking at debt, the majority of funds should be applied to the debt with the highest interest rate, while paying the minimums on the others,” said Brenda Hiscock, a financial planner at Guilfoyle Financial in Toronto and a member of Advocis, the Financial Advisors Association of Canada.

“Once the first debt has been paid off, the funds that were being applied to that debt now go to the debt with the second highest interest rate, and so on.”

Iman’s may be a solid plan but it’s not fool-proof.

“The one risk that she may face is if that 4% (on her student line of credit) is a variable rate,” Hiscock said.

“We’re in a rising interest rate environment and that will eventually be bigger than the 5.5% OSAP loan.”

Iman will also have to stay on top of the OSAP repayment assistance program by reapplying every six months and there’s no guarantee she’ll qualify every time.

If she doesn’t, she’ll have to switch gears and focus on paying down her OSAP loan instead since it costs more to carry.

Iman’s lump sum payment strategy for the OSAP loan only makes sense providing she continues to receive interest forgiveness.

She shouldn’t be sinking any excess money in OSAP until the time comes, Hiscock said.

“I’d be throwing money into a high-interest account and the day that the forgiveness ends, is the day I put that whole lump sum of money toward OSAP.”

Even with a more than $28,500 debt burden, the future looks bright for Iman. She looks forward to the day when she can start growing her savings for travel and eventually parenthood.

“I get the sense she’s a good money manager,” Hiscock said.

Iman’s diligence means she’s not having cash-flow problems so debt consolidation isn’t necessary.

Not everyone is so lucky. Roughly one in 10 Canadians is in a vulnerable financial position–meaning that the cost of servicing their debt consumes more than 40% of their income. That’s when most people start to have issues in making their debt service payments.

Hiscock’s rules of thumb for indebted Canadians:

Have a 3-year plan. If debt repayment seems impossible within three years, then consider a consolidation loan, trimming your budget, or boosting your income.  Sometimes people have to take a second job in order to get their finances in order in the short term. Exceptions to this are student loans which can go up to 5-7 years, and of course a mortgage.

Follow the 40% rule. No more than 40% of income should be used to pay household expenses and debt combined (ie. rent/mortgage, property taxes, heat/hydro, loans etc.) If you’re spending more than 40%, it’s time to consider downsizing. Track your expenses by downloading Hiscock’s monthly budget spreadsheet.

Watch your credit cards. If you have multiple credit cards with balances, and they are not reducing over time, consolidate the balances, get rid of all cards except one and reduce the credit limit on that card.

Make saving a priority. Make sure that funds are being put away for savings, regardless of your financial situation.  Even when dealing with debt, 5% of income should go into savings, working towards 10% in the future.