Tuesday, September 19, 2017

Calculated Thought: Student-loan interest rate getting lower

September 5, 2017 by Sean Annable, contributing writer

Effective August 1, interest rates for both variable and fixed-rate student loans have been reduced from prime plus 2.5 percent and prime plus 5 percent respectively, with both options now charging only the prime rate. The move, announced earlier this year by the Liberal provincial government, was followed by a proposed elimination of all interest promised by the newly formed NDP government.

This applies only to the provincial portion of the loan; the federal portion will remain at the same rates described above.

The Bank of Canada (BOC) raised the key rate—for the first time in seven years—a quarter-point to 0.75 percent. For most students, this marks the first time in their adult lives when the cost of borrowing money will rise.

Calculated Thought is a column dealing with student finances that is featured in every issue of Nexus.

Those funding their education with lines of credit from the bank will notice their interest rate has gone up with the BOC announcement, as the prime rate for all major lenders went up from 2.7 to 2.95 percent. This is the rate used to calculate the interest you’ll pay after graduation on government loans as well, so current students may see the highest rates on the federal portion of variable-rate loans since 2010 if the BOC continues to up the key rate.

Forecasts show that the overnight rate could peak at 2.5 percent by the end of 2019. If the current spread of 2.2 percent stays constant, this would mean a 4.7 percent prime rate by that time.

So, for those graduating this year, choosing the variable-rate option has become slightly riskier but still seems like the better choice. If you locked into a fixed-rate repayment agreement today, your rate would remain constant at 7.95 percent. Opting for the variable rate would mean a 2.5-percent addition to the prime rate as it fluctuates. Prime would have to reach 5.45 percent to make this option more expensive. That could happen—rates were within the 6-percent range in 2008. Rates could also stall, or even go down again. Over a repayment period of a decade or more, a lot could change.

The rate reduction, and possible elimination of interest on provincial loans, will help with the risk of rising rates and, I think, is a step in the right direction to support education in Canada. Opponents argue that this removes incentive to pay back borrowed money; however, there will still be minimum payments under the NDP plan. Defaulting on your loan will still have the same adverse consequences. Whether students will opt to take more time to pay back a zero-interest loan making only minimum payments is another scenario. I hope, with reduced strain on the finances of new graduates, students will find it easier to succeed in their fields and be able to better manage their student debt.

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