A Guide to Student Debt

Congratulations, you graduated from school and have now boosted your earning potential. If you took on debt to get there, as roughly 43 percent of Canadian students did, you’ll want to pay it off as soon as possible to minimize the amount of interest you’ll have to pay.

Now that you’re in the workforce, you may have begun to ask yourself what comes first, paying off student loans or saving for retirement? Many assume planning for retirement and paying off student debt are mutually exclusive and you have to pick one or the other. The truth is it’s not that simple and waiting to save for retirement until your loans are completely paid off may not be the best way to take control of your finances. There’s nothing like time to turn your retirement contributions into a pot of gold – thanks to compounding interest. So while there is no set answer, delaying your retirement savings isn’t recommended.

Here are a few financial planning steps on the priority list that most often should be completed before tackling that student debt with extra payments.

Know your financial life goals

Having student debt is sure to put a burden on your monthly budget. However, your loan payments should not prevent you from pursuing important life goals such as purchasing a home, taking that dream vacation or growing your family.  While your budget may seem tight as you make the necessary payments, make sure you have a financial action plan in place. This can help provide you with guidance when it comes to prioritizing how you want to spend your time and money. By taking the time to know your goals and identify what you need to do to make them a reality, the likelihood of achieving them increases.

No matter your current financial situation, having a financial plan is useful no matter what, and can help you accomplish extraordinary things in your life. You may assume that your student loans mean that you won’t ever be able to purchase a home or begin to save for your retirement, but with a financial plan, you can find the best way to fit student loan payments into your financial life.

Track and plan your money outflows

It’s important to your financial stability that you track your expenses. However, it’s even more vital that you go beyond how you’ve spent your money in the past and create a spending plan, so you know where your money is going in advance. Despite the importance of having a budget,  only 47 percent of Canadians are using one to track their income and expenses regularly.

Create a budget that will help you prioritize your spending so that you can pay off your loans more quickly. The sooner you rid yourself of debt, the faster you can begin to focus on other financial goals. A budget identifies gaps in your finances where you can cut back. Keep in mind that it’s easier to cut back on expenses when you are a recent graduate and are used to living on a minimal income.

Your student loan payment amounts will depend on the repayment plan you have chosen. When incorporating this into your budget, make sure you are estimating how long it will take you to pay off the debt, keeping in mind how much total interest you’ll be paying over the lifetime of the loan. Having a financial plan will work these debt payments into your budget while also identifying ways to save for your retirement, so that’s another reason to make a plan.

Build and maintain an emergency fund

Even if you are focusing on paying off debt, not having any money set aside for emergencies could seriously dig you into a bigger hole. It’s unfortunate, though, that almost a quarter of Canadians are living paycheque to paycheque and saving no money. If faced with an emergency, a quarter of Canadians would not be prepared. Don’t fall into this bucket.

An emergency fund contains easily accessible funds held either in cash, a basic savings account, or a tax-free savings account (TFSA). The purpose of this cash is to protect you financially in case of an emergency. For example, unexpected car repairs or home maintenance, vet bills, or job loss.

It will sit there, untouched, waiting for the unexpected cost to come up. An emergency fund is necessary to avoid more costly debt or personal loans if any unexpected medical, auto, or home expenses occur.

As a best practice, you should look to save three to six months of after-tax income. There is an endless debate about this and, the truth is, like many personal finance rules, it’s different for everyone. For example, a family of five with a mortgage and two vehicle loans will require a larger emergency fund than a newly-wed couple with no children.

Pay off high-interest debt

When it comes to paying off loans and other debts, it’s crucial to your success that you realize some types of debts are more harmful to long term prosperity than others. Low-interest student loans or a mortgage are, overall, a lower priority. For other, more expensive types of debt, such as credit cards that hold interest rates greater than six per cent, the best way to prioritize them is to get rid of the highest interest debt first then go down the line.

We usually recommend the debt avalanche (sometimes called “snowball”) method. First, list your debts from highest interest rate to lowest, regardless of the total balance. Then put any extra money you can find in your budget toward the one at the top. Once that’s paid off, forward all the money you were using as payment for the debt to the next debt on your list. Then continue to work your way down the list.

Make your retirement a higher priority

It can feel challenging to save enough for the future if you are in the early career stages and feel burdened by your student debt. While attacking your student debt may seem like the highest priority, it’s recommended to save at least 10 to 20 per cent of your income to achieve financial independence. Prioritizing your retirement savings ahead of making extra payments on your student loans allows you to take full advantage of the power of compounding interest. If you put money in retirement accounts as soon as you start working, you will find that your savings begin to build faster.

Don’t let your retirement suffer by not saving enough. Not sure how much you should be saving for your retirement? A good rule of thumb is to put 15 percent of each paycheque towards a registered retirement savings plan (RRSP), TFSA or other savings vehicle.

Get control of your student debt

Student loans can be daunting, and it might take a good amount of time and effort to get rid of them. But they don’t have to take over your entire financial future — smart planning and hard work can get you there.

Start by creating a budget that will help you prioritize your spending, so that  you can pay off your loan faster. If you get a raise or a bonus, consider putting that money directly toward repaying your debts instead of taking on new expenses or spending it on a purchase. Remember, the sooner you are out of debt, the sooner you can work on your other goals. By working to find extra money to put towards your student debt, you can accelerate your payoff process. This can mean taking on a second job or cutting back on the things you do not need, such as an expensive gym membership or a vacation.

The first step you can take to get control over your student debt is to have a simple and flexible financial plan.