You’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 private student loan like a student line of credit or credit card. If you are carrying more than one type of debt, which one should you pay off first? What are the differences in terms of repayment requirements and student debt forgiveness options?
Private Student Loans, Student Line of Credit vs Government Student Loans
It is important to know whether your student loan debt is from a government guaranteed student loan program like OSAP or if it’s a private loan from a bank, credit union or other financial institution.
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. Interest is not charged on the loan and you are not required to make any payments while you are in school.
A private student loan is not government guaranteed. It’s a loan you get from a bank and can take the form of a student line of credit, term loan or student credit card. In practical terms, it’s 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.
Student Loan Repayment Options
When do I have to start making payments on my student loans?
Most recent graduates are eligible for a six-month grace period on Canada student loans during which you do not have to make any payments. While you do not have to make any payments during this time, you will be charged interest on the Canada portion of your student loans from the day you graduate. Current Ontario legislation provides you with a payment and interest-free grace period of six months on your Ontario OSAP loans. We recommend you check with your provincial student loan office to confirm whether interest will be charged for your provincial student loans.
Whether you should take advantage of this grace period is up to you, however, the sooner you pay off your student loans, the less you will pay in interest in the long run. If you are unable to find a job right away or need money to relocate or set up your new living arrangements, it may make financial sense to delay your payments and take advantage of the deferment.
Private loans are another matter. If you have taken out a line of credit from the bank to fund your education, interest is charged as soon as you draw on the loan. You will have already been required to make the minimum monthly payments on student credit cards while you were in school, which is usually interest plus 1 to 5% of the loan balance. If you have a term loan, your student loan provider may have defer principal payments until 12 months after graduation, however you are charged interest on all monies loaned to you from the day they are advanced.
Choosing which loan to pay off first
Financially, you should always pay off high interest rate debt first.
Create a personal budget based on your income and monthly expenses, and determine how much discretionary income you have available to put towards student loan repayment. This will help you make a plan to pay down student debt.
- If you carry a balance on a high-interest credit card, plan to pay that down right away.
- If you have student lines of credit keep up with all minimum payments.
- Prioritize any student loan guaranteed or co-signed by your parents or other family member so your co-signor is not at risk if you can’t pay.
- Next, focus on making the monthly payments under the standard repayment plan terms of your National Student Loan Service Centre consolidation agreement.
- You can also make lump sum or extra payments at any time which will be applied to any interest owing first, then to the principal. Review your budget for any discretionary income that can be applied towards your student debt to pay it off sooner.
The dangers of paying off government Student Loans with private loans
Student debt consolidation is not generally recommended in Canada. A consolidation loan repays an old debt and replaces it with a new debt. A student debt consolidation loan would be new debt, and as such is no longer technically a student loan. There are negative consequences of converting government guaranteed student debt into private student debt:
- If you have government guaranteed student loans, your current interest rate is likely lower than any student debt consolidation loan.
- Converting government guaranteed student loans to a private debt consolidation loan will eliminate any student debt tax benefits (interest on eligible student loans is a non-refundable tax credit).
- You will also no longer qualify for any government repayment assistance program.
- Banks and financial institutions in Canada are unlikely to approve a consolidation loan for student debt.
- If you cannot afford your low interest student loan payments, you likely cannot afford a consolidation loan.
A consumer proposal is often a more viable mechanism to consolidate old debt, including eligible student loans, into one monthly payment if you cannot afford to repay your loans.
Implications of failing to repay student loans
Falling behind on your student loan payments will have a negative affect on your credit score. Both Canada student loans and private lenders will report late payments and accounts in collection to the credit bureaus.
If you do not make the required loan repayment on a student lines of credit or credit cards the bank can apply to the court to garnish your wages. Failure to pay off co-signed student loans will result in your student loan servicer or lender looking to your co-signor to pay off the loan. If you don’t make your required payments the government has the power to take your tax refunds. Both federal and provincial governments have the power to garnishee your wages without going to court.
If you are having trouble keeping up with your Canada student loans you can apply for a revision of terms, which will allow you to lower your monthly payment and extend the length of time it will take to repay your loan up to a maximum of 15 years. You can also see if you qualify for income-based repayment adjustments through the federal Repayment Assistance Program.
How to Get Help Paying Off Student Loans
What happens if you ultimately can’t meet your student loan payment obligations? Almost one in five insolvencies in Canada each year involve student loan debt. You are not alone in considering student debt forgiveness programs like a bankruptcy or consumer proposal.
In terms of student debt forgiveness 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 if you declare bankruptcy or file 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.
If you cannot afford to pay your student debt on your own, have been out of school for 7 years or have significant other debts, use our debt repayment calculator to estimate what your payments might be in a consumer proposal.
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.
We cover these topics and more in our student debt help FAQ page.
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. If you are struggling with student debt, contact your nearest debt help location for a free consultation. We’ll explain all your options and help you make a plan to eliminate your debt.