Repaying Student Line of Credit versus Student Loans

Posted in Debt Help
Posted by J. Douglas Hoyes, CA, CPA, LIT, CIRP, CBV

student-debt-help-updatedYou’re out of school, found a job, and now it’s time to pay off your student loans. In Canada student debt can take two possible forms: a government guaranteed student loan and a private student line of credit. If you are carrying more than one type of debt, which one should you tackle first, or are they the same?

The short answer is no, there are some significant differences between a government student loan and private loans in terms of qualification, interest charges, repayment and even debt relief.

Financial Differences

A traditional Canada student loan is guaranteed by the federal or provincial government. Qualification is based on need, you receive funding as you attend school however interest is not charged on the loan while you are in school.  In addition you have a six month grace period after graduation where you do not have to make any payments.

A student line of credit is not government guaranteed.  It’s a loan you get from a bank, and in practical terms, it’s exactly the same as any other bank loan. Why would a bank loan money to a student who is going to school, has no job and is not guaranteed by the government?  Isn’t that a big risk for the bank?  Not really, because the banks typically give student lines of credit to students that have good job prospects because they assume that once you are working you will have the income to repay the loan. They may also ask for a parent to co-sign the loan or provide collateral perhaps in the form of a home-equity line of credit.

Implications of Non-payment

If you are having trouble repaying your government guaranteed student loan you can apply for help under the Repayment Assistance Plan, however, if you don’t make your required payments the government has the power to take your tax refunds.  Both federal and provincial governments also have the power to take you to court and garnishee your wages.

However, with student lines of credit there is no grace period for interest. While you can typically defer principal repayments until 12 months after graduation, you are charged interest on all monies loaned to you from the day they are advanced. In addition, you will have to make minimum payments to cover interest on any borrowings while you are in school.

If you do not make your payments on a student line of credit the bank can apply to the court to garnish your wages, and if you have a co-signer, will pursue them for payment.

So which should you pay first if you have both a student loan and a student line of credit?

If you have a decent income, the starting point is to make your minimum payments on both loans and pay extra on your highest interest rate loan.  By paying the higher interest loan off faster, you save a lot on future interest payments.  That’s the simple strategy, but there are some exceptions to the “high interest first” rule:

  1. If one of your loans has a co-signer, you may decide to prioritize the repayment of the co-signed loan to protect your co-signer.  So if your parents co-signed your student line of credit, you may decide that’s the loan you want to repay first, so that your parents are not at risk if you can’t pay.
  2. Another consideration will be if there are any special terms.  Since Canada student loans allow you a short interest free or “payment holiday” period immediately following graduation, or during periods of unemployment, it may make sense to defer payments on the student loan and use your funds to accelerate payments on your student line of credit.  Before you do this, read the fine print: if all you are doing is accumulating more interest by not paying, that may not be a prudent strategy.

Student Debt Help Options

What happens if you ultimately can’t meet your payment obligations?

In terms of student debt relief options, there are differences between the treatment of Canada student loans and private lines of credit.

Government guaranteed student loans are covered by special rules under the Bankruptcy & Insolvency Act. A government guaranteed student loan is only automatically discharged in a consumer proposal or bankruptcy if you have “ceased to be a student” for over seven years.

A student line of credit, however, is a private loan between you and the financial institution, and as such, is treated like any other debt. If it is an unsecured loan (in other words the bank gave you a line of credit and did not ask for any type of collateral), then these loans would be eliminated by bankruptcy or a consumer proposal with no waiting period. If you graduated two years ago and declared bankruptcy today, your student line of credit would be eliminated by your bankruptcy just like any credit card debt you have.

However, if someone co-signed your student line of credit, then your bankruptcy will not eliminate their obligations under the terms of the loan agreement; your bank or credit union will pursue your co-signer. Similarly, if you provided any security for the line of credit, then any secured debt remains — it is not forgiven in a bankruptcy.

Again, which form of student debt relief you need will depend on your situation, including which type of student debt you carry, how long you have been out of school and what other types of debt you may have.

student line of credit vs student loans