Is repaying student debt early the best investment you can make?

Recently came across a regular Q&A column where a financial planner advised a recent grad to pay off their student debt first before investing their money. These type of articles are limited because the planner can't ask the required fact-finding questions to best understand the individual's unique situation but paying off student loans vs saving and investing is a frequent question I come across with my younger clients.

Being aggressive with paying off student debt can be great depending on what your investment goals are. Most adults in their late 20s to early 30s want to save for a home, which is a form of investment itself. While paying off student loans can help free up both credit capacity and monthly cash flow it will also take a longer time to save up that 5, 10 or 20% for a down payment.

Even though housing growth is slowing down in the GTA, the average Toronto condo price grew by 7.9% from Jan 2017 to Jan 2018, which exceeds the current 6.2% OSAP interest rate. The new mortgage rules have made qualifying for a mortgage more difficult for most potential buyers but a mortgage agent can confirm if its possible to include some or all of your outstanding debt into a mortgage, meaning the higher down payment you can save towards could be beneficial in helping to reduce or cover all outstanding debt in a mortgage.

If home ownership is not a goal or if you already own a home, consider the opportunity cost between paying off student loans versus traditional investing. If Canada Student Loan rates are 6.45% annual any investment you engage in has to consistently perform over 6.45% annually to make it worthwhile, otherwise you will end up paying more in loan interest then you will make in investment interest. Before the recent interest rate increases, allocating more of your surplus cash to investing was a good strategy for some but now that has changed. For conservative or balanced investors who will, on average, achieve 3 to 6 % growth annually, focusing more on paying off student loans may be best. For aggressive investors who could potentially see 8 to 10% or more in returns you need to weigh the risk of not having a great investment year and making less interest then the loan interest you are charged through your student loans. If you have just Ontario Student Loans, the current rates are Prime + 1 % so 4.95% is the benchmark you need to consider.

Overall, solely focusing on debt reduction will leave you debt-free, but also savings-free. Determining a suitable cash allocation between debt reduction and investing is best and you can use an interest calculator to determine how much you can save overtime if you increase your student debt payments versus compound growth in an investment.

Michael Thorpe