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 Posté le: Mer Oct 16, 2013 7:37 am Sujet du message: somewhere in between’ |
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{A graduate’s $52,000 student loan repayment dilemma }
Featured VideoClose More Video Original Apple 1 Computer Sold for Nearly $700K Oil Prices Dip on Dollar Rise Sandra, 26, has a master’s degree in public health. She earned $51,000 in contract work last year.She also owes $52,000 in student loans after paying for her education without help from her parents. “Since graduating in 2011, I have been in savings mode and have been paying back only the minimum required balance each month,[url=http://www.toms-shoes-sale.com]Toms Shoes Outlet[/url],” she said.“I have seen my friends put all the money they made into their student debt and then live paycheque to paycheque as a result. I want to avoid this.”Sandra attended my personal finance course at the University of Toronto’s school of continuing education. After hearing me talk about the importance of paying off debt quickly, she asked me a question.“How should one manage one’s ‘good debt,’ such as student loans?,” she asked. “Does the ‘get rid of it quickly’ mentality apply to good debt as well?”Her case is unusual because she’s an excellent saver. She has $31,000 in a tax-free savings account and registered retirement savings plan,[url=http://www.toms-shoes-sale.com]Cheap Toms[/url], plus $20,[url=http://www.toms-shoes-sale.com]Toms Shoes Sale[/url],000 in a nonregistered savings account.“I have the means to pay back a large portion of my student debt,” she said. “But I am not sure if I should be doing this right away or if I’m better off doing other things with my money.”I asked fee-only financial planner Jason Heath, managing director of Objective Financial Partners, to advise her. First, he asked Sandra a few questions.How much money does she save?She has $2,500 left over each month after paying expenses and rent on an apartment she shares with her boyfriend.What does she have in her tax-free savings account? She has $8,500 in savings, earning 1.15 per cent, and $13,000 in guaranteed investment certificates, earning 2.5 per cent to 3.1 per cent.Does she consider herself a conservative or aggressive investor? “Mostly conservative,” she replied, “but I am leaning more toward ‘somewhere in between’ and I’m interested in exploring mutual funds and ETFs (exchange-traded funds).”Does she plan to buy a home with her partner? What about marriage and children?A home purchase is probably three to five years away, she said. Starting a family may happen within eight years.After crunching numbers, Heath advised Sandra to pay off her debt more quickly.Yes, student loans provide a tax credit on federal and provincial tax returns. But even more important is the after-tax cost of debt and the after-tax return on savings and investments. Here’s how the math works out in Sandra’s case: The $10,000 Alberta student loan is at a 3 per cent variable rate, giving her an effective rate of 2.4 per cent once the tax credits are factored in.The $42,000 federal student loan is at a 5.5 per cent variable rate, giving her an effective rate of 4.4 per cent. The money in her taxable savings account is earning 1.2 per cent. Since she’s in a 31 per cent marginal tax bracket, her after-tax return is only 0.8 per cent. The money in her TFSA has an after-tax return of 3.1 per cent at best and 1.15 per cent at worst (since a TFSA allows tax-free growth). “Your debt is growing faster than your investments, meaning you’re no further ahead preserving your ‘good debt’ in order to invest,” Heath told her. “In fact, you’re falling behind.” She should try to repay student loans when interest rates were low, he said. “If you don’t pay down your debt now, that will leave more debt at risk of higher rates and a higher after-tax return hurdle you need to achieve in order to break even, let alone come out ahead,” he pointed out.She may want to take on other debt in the future. But her student loans could hurt her ability to get a mortgage for a home, since banks look at the amount of other credit outstanding.Paying down her federal student loan will give a guaranteed after-tax return of 4.4 per cent. That’s the equivalent of buying a 6.4 per cent GIC.“You are a conservative investor,” he said. “Conservative or not, that’s a pretty decent potential return.”Yes, she can become a more aggressive investor and keep the debt in place. If she earns more than 4.4 per cent after tax, she comes out ahead.However, stock markets are at a high level and can fall any time. They may take years to recover.What if Sandra is out of work and has to cash her investments at a loss? What if she and her partner want to buy a house in three years? That’s a short time frame in which to take more risk with their savings.“You’re young and you’re on the cusp of a lot of exciting things,” he advised her. “Keep your finances simple. Paying down debt is a pretty easy investment decision and requires little monitoring.”His advice to Sandra: Don’t use every available cent for debt repayment. Start by taking $3,500 of the $8,500 in cash in your TFSA and $18,000 of the $20,000 in your nonregistered savings account.“Putting a $21,500 lump sum down against the federal student loan will really accelerate your repayment,” he said. Sandra had a final question: When could she start contributing to a TFSA? Heath replied that he and his wife were still paying down a mortgage. Neither of them had a TFSA.“I don’t see a compelling reason to invest in a TFSA at a low guaranteed return (GICs) or a potentially higher unguaranteed return (stocks),” he said, “when there’s a middle-of-the-road guaranteed return on debt repayment.” His conclusion: You don’t have to buy assets to increase your net worth. Paying debt has a higher probability of increasing your net worth with the least amount of risk.More Monday Makeover stories
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