Personal Finance

Pay off Student Debt with HELOC or with Mutual Funds

  • Last Updated:
  • Jun 14th, 2019 11:15 pm
[OP]
Newbie
Jun 10, 2019
4 posts
1 upvote

Pay off Student Debt with HELOC or with Mutual Funds

Hello all,

I recently graduated from university and racked up approximately $50,000 worth of student debt. During my time in school, my wife and I managed to put some savings into our mutual funds which have also grown to approximately $50,000. We also have a HELOC that has a max limit of $110,000. My question to you during my analysis: do I take out all of my money from my mutual funds and pay off my student debt now, or do I pay off my student debt with my HELOC that can eat this up and keep the money growing in the mutual fund. I've compiled a table with various scenarios and additional info that helps is that the $50,000 in student debt from OSAP has interest rates of 6.45% on the federal portion ($33,356), and 4.95% on the provincial portion ($16,643). I know that if I used my HELOC to pay off my student debt, I can lock in an interest rate of 3.05%. Furthermore, the analysis assumes that the mutual funds will appreciate at 7% per year, and this, I believe, is a safe assumption.


My observations are that it makes no sense to leave the money with OSAP (option 1). Furthermore, it looks like it wouldn't help even if I used $10,000 to pay of my student debt, as I would lose ~$10,000 after 10 years (Cumulative).

I'm leaning towards paying off my student debt with my HELOC, and permitting the mutual fund to nicely grow at the assumed rate of 7%.

Is there something missing in my analysis, or is there advice that some of you can give me on this long term plan. Any help/advice would be nice.

Thank you in advance.

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12 replies
[OP]
Newbie
Jun 10, 2019
4 posts
1 upvote
To my understanding, the tax deductions from the OSAP interest over the 10 years does not make sense to pay the ~$16,500 in interest to OSAP as the interest rates are higher. It seems like using the HELOC to pay off the student debt makes more financial sense as interest charges over 10 years would only amount to ~$8,070. I don't think that I'll be able to save $8,500 from tax deduction if I left the money in OSAP. Please correct me if I'm wrong.
Member
Jun 2, 2007
377 posts
33 upvotes
Toronto
7% return is not a safe assumption. Your future expected return is directly correlated with the price you pay for an asset, which is in part determined by where we are in the economic cycle. Assets are very expensive right now with a lot less upside than they have been at other parts in the cycle.

For example - take a look at an investor's 10 year returns buying into the TSX in May 2008 vs buying into the TSX in March 2009.

https://www.morningstar.com/articles/90 ... rns-2.html
Deal Fanatic
Nov 24, 2013
5544 posts
2144 upvotes
Kingston, ON
Are your mutual funds held in a non-registered account, a TFSA, or an RRSP? What will your approximate income be moving forward?

I think at a base level locking in $50,000 of HELOC borrowing at 3.05% to zero out the debt makes sense, but holistically I think you want to maximize your mutual funds held in TFSA, or potentially RRSP if you'll be at a high marginal tax rate moving forward, rather than keeping $50,000 of mutual funds non-registered.
Deal Fanatic
Nov 24, 2013
5544 posts
2144 upvotes
Kingston, ON
quick90 wrote:
Jun 12th, 2019 8:46 am
7% return is not a safe assumption. Your future expected return is directly correlated with the price you pay for an asset, which is in part determined by where we are in the economic cycle. Assets are very expensive right now with a lot less upside than they have been at other parts in the cycle.

For example - take a look at an investor's 10 year returns buying into the TSX in May 2008 vs buying into the TSX in March 2009.

https://www.morningstar.com/articles/90 ... rns-2.html
7% nominal (not real) is an appropriate and actually conservative estimate for average returns over a 30 year time horizon. 10 years is subject to where things are in the business cycle, true, but for what it's worth OP appears to be looking at it over 10 years to compare to the loan period; not actually planning on withdrawing the investment in 10 years.

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Your link doesn't seem to be a May'08 vs. Mar'09 10-year comparison, but rather a list of various long-term market return forecasts.
[OP]
Newbie
Jun 10, 2019
4 posts
1 upvote
The mutual funds are in a TFSA, and I have no plans of taking it out in the next 10 years. My wife's and my salary make it possible for us to pay down our current condo mortgage, the proposed HELOC payments (Options 2-5) and save a bit per month.

With this 10 year analysis and looking at Option 2 where the mutual funds in the TFSA are untouched, monthly payments of $483 for the HELOC are very comfortable while ultimately only paying $8,075 makes great financial sense.
Deal Fanatic
Nov 24, 2013
5544 posts
2144 upvotes
Kingston, ON
User388552 wrote:
Jun 12th, 2019 1:41 pm
The mutual funds are in a TFSA, and I have no plans of taking it out in the next 10 years. My wife's and my salary make it possible for us to pay down our current condo mortgage, the proposed HELOC payments (Options 2-5) and save a bit per month.

With this 10 year analysis and looking at Option 2 where the mutual funds in the TFSA are untouched, monthly payments of $483 for the HELOC are very comfortable while ultimately only paying $8,075 makes great financial sense.
I'd definitely go with that Option 2 then. You're getting the most out of your TFSA the longer the funds are in there compounding. Better to pay $483*120 in inflating dollars than to, say, take the $50K out of the TFSA and contribute $483/mo back to the TFSA. The interest you pay is less than the growth you'd be missing out on.
Deal Addict
Jan 19, 2017
1387 posts
494 upvotes
zeddy wrote:
Jun 11th, 2019 8:12 pm
OSAP loan interest is tax deductible. HELOC interest is not.

https://turbotax.intuit.ca/tips/tax-tip ... erest-5580
Because the interest rates of 6.45% on the federal portion ($33,356), and 4.95% on the provincial portion ($16,643), he is paying 33356*.0645 + 16643*.0495 = 2975.29 which is = 5.95% on $50000. If his marginal tax rate is 50%, then the after tax rate is about 3%. It will be 3.6% after tax if his marginal tax rate is 40%.
Newbie
Sep 10, 2017
95 posts
81 upvotes
ml88888888 wrote:
Jun 13th, 2019 6:38 pm
Because the interest rates of 6.45% on the federal portion ($33,356), and 4.95% on the provincial portion ($16,643), he is paying 33356*.0645 + 16643*.0495 = 2975.29 which is = 5.95% on $50000. If his marginal tax rate is 50%, then the after tax rate is about 3%. It will be 3.6% after tax if his marginal tax rate is 40%.
Be very careful about the marginal tax rate discussion. The marginal tax rates do not matter since the interest is a non-refundable tax credit, not a tax deduction.

This means you will only get 15% of your interest rate back on your Canadian portion of taxes (line 319), and some percentage depending on the non-refundable tax credit rate (5.05% in Ontario, 10% in Alberta, etc) on your provincial portion of taxes (Line 5852).
So regardless of income, (as long as you have paid some taxes) the interest on your student loans is reduced by 20.05% in Ontario. So the average interest rate of 5.95% obtains a tax return of 20.05%*5.95% = 1.19%, leaving the effective interest rate after account for taxes at 4.76%.

I did hear in Canada's Budget 2019 that the Federal portion of student loans will reduce the interest rate to prime, currently at 3.95%. I'm not sure when this will happen. The effective interest rate after taxes using 3.95% for Federal loans is 3.42%.

In my opinion, the HELOC at 3.05% is a better option than keeping student loans, with the risk of losing out on possible RAP/government help/government changes to student loans. Mathematically using HELOC to pay off student loans makes the most sense.

Keep in mind choosing to keep 50,000 invested in a TFSA instead of paying off HELOC of 50,000 is equivalent to if you chose to take out $50,000 on your HELOC to put into a TFSA (borrowing to invest). If your comfortable with that risk, I'd say use the HELOC, and pay it down with any extra money you come across since you never know what will happen with interest rates, and you don't want to put your house at risk.
[OP]
Newbie
Jun 10, 2019
4 posts
1 upvote
Awesome feedback and advice RFD!! I know my strategy for option 2 is borrowing to invest, but my wife and I have gained significant equity in our condo since its purchase, and we are both comfortable with this.

I read about the student loan interest is a non-refundable tax credit, but this benefit does not outweigh the cumulative interest fees over this 10 year plan and is not superior to the 3.05% interest rate offered by the HELOC.

The plan is to pay down the $50,000 in the HELOC as fast as possible, but the monthly payment of $483 is very comfortable for us. All of your advice has helped me gain confidence in my strategy. Thank you!
Newbie
Feb 26, 2002
88 posts
12 upvotes
Toronto
Sounds like you have a good handle on your finances so I agree with the consensus & pay-off with your HELOC.

Further, I would suggest replacing your Mutual Fund with an ETFs. Mutual Fund fees are too high in Canada and rarely outperform their benchmarks. More than 75% of Canadian active equity managers underperformed their benchmarks across all categories in 2018.

https://static.twentyoverten.com/5b466f ... d-2018.pdf

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