The ugly truth about Government student loans

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A growing number of high-school graduates turn to government student loans to finance their post-secondary education. Adults returning to school full-time may also elect to do so. I was one of them. There is a number of reasons why:

–   parents haven’t been able to set aside enough money into an RESP

–   not enough personal savings

–    inability to obtain financing from a bank

But most importantly:

–   government student loans are fairly easy to obtain

–  no interest is paid by the borrower during the course of studies

After graduating, a number of people choose to remain at government level when it comes to repaying these loans:

–  repayment can be extended up to 10 years

– greater flexibility in payment amounts

–  repayment assistance in case of difficulties

– 6 month “grace period” after graduating when no payment is required

–  Interests paid on government student loans result in a tax credit

Unfortunately, many people don’t realize there is a very high price-tag to this convenience. The amount of interest paid on government loans will usually far exceed what you would pay at any financial institution for the same amount of money.

The current interest rates for a Federal Govt. student loan are as follow:

–  Fixed: prime -3%- + 5%, i.e. 8%…ouch!

– Floating: prime -3%- + 2.5%, i.e. 5.5%. If the prime rate goes up, so will the overall interest rate.

Let’s assume you have an $ 8 000 loan and choose the fixed-rate. You took advantage of the “grace period” and did not make any payment for 6 months. You also decide to stretch the repayment for the full 10 years. At the end of this period, the total amount repaid will be over $ 12 000 with more than $ 4 000 in interest!

You are not better off with the floating rate. Assuming it doesn’t change for 10 years -very unlikely!- the total amount repaid will be just under $ 11 000 with around $ 2 500 in interest.

The “grace period” is not really one. Interests start accumulating as soon as you are out of school. These are not eligible as a tax credit and they are added to your principal after 6 months. Yep, you will pay interest on interests!

Last but not least, government student loans cannot be included in a bankruptcy or consumer proposal, unless you have been out of school for at least 7 years.

The best course of action may be to try and consolidate all your student loans with a financial institution. If you can’t, aim to repay them within 5 years and do not use the “grace period”. In the first place, you need to make sure that you don’t take more debt than you can handle.

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