The Price is Wrong: Part 2

 

In the last post, I gave up my neutrality and urged Canadian students to just say NO to today's fixed-rate student loans.

Most governments are over-charging to the point where these loans will almost certainly cost you thousands of dollars more than variable (floating-rate) loans.

Fixed-rate student loans normally cost a bit extra because you're getting the security of locking in today's student loan interest rate, so it won’t go up in future.

That's understandable. But most Canadian governments charge so much for this security that – in today’s economy – you’ll probably just get burned.

Here’s an example of how much extra some governments charge for a fixed-rate loan.

Manitoba – where floating student loans are now below Canada’s average at 3% – will let you ‘lock in’ to a fixed-rate student loan. But you’ll have to pay 4% more than the prime rate. At present, that’s 7 percent. So you’d be paying more than double.

And that’s not the worst.

Canada (the federal government), New Brunswick and British Columbia (BC) Student Loans soak you even more. They charge an extra 5% over prime for a 10-year fixed-rate loan.

To see why that’s unfair, look at Canada’s mortgage rates. You can easily lock into a 10-year fixed-rate mortgage over for 1% more!

That’s right. These governments are charging students at least several times more for the security of a fixed interest rate than homeowners pay on the open market.

I think that’s unacceptable. It takes advantage of a captive market of student debtors.

These unfortunate students will be stuck paying 8% while grads with floating loans pay somewhere between 2 and (maybe) 6 percent, depending on how the economy goes.

The fact that lower-income students are more likely than others to choose fixed-rate loans makes this even more regressive.

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As a student, what does this cost you (or your parents) in cash? Take a look at how much extra the above 3 governments would take if you chose their fixed-rate student loan option:

• They'd take much bigger monthly payments than you'd pay with floating (variable) loans. At the current rates, the payment on a $25,000 student loan over 10 years would cost you over $300 each month, compared to $240. (You'd be better off putting that extra 60 bucks into faster payment of your floating loan, which would save you even more money.) 

• Over the life of your loan, that 5% premium on a fixed-rate $25,000 student loan could leave you paying an extra $10,000 or more.

What a steep price for security! Students who worry about rising rates choose the fixed-rate loans and then get hosed.

Given our economic outlook, Ontario probably does students a favour by not offering a fixed-rate option. And, of course, there are no fixed-rate provincial student loans in Newfoundland/Labrador and PEI because they don’t charge interest, bless ‘em.

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But what about all that risk, you ask?

Listen, unless central banks go back to the ‘stagflation’ policies discarded in the 1990s, we’re not going to shoot into double-digit interest rates in the next 10 years.

Ten years is the standard Canadian student loan term when you include the 6-month ‘grace period’.

And our current mortgage rates are based on calculations that we probably won’t see interest rates rise more than 1 or 2% in that entire 10 years.

I see a hand waving in the back. Umm, what if you’re planning to repay your student loans over the extended term –which is 15 years?

Yes, that is a long time. Maybe things will change so much that you’ll be glad you locked in this year at 8%. But based on bond and mortgage outlooks, I wouldn’t. On the other hand, I also wouldn’t take that long to pay. In this market, 8% is too expensive!

As one Manitoba Loan Services rep advised, “You’re much better off with the variable rate.”

Variable loans may feel scary. No one knows where their rates will float. But today’s long-term forecasts show that most Canadian governments are raking in too much of a ‘risk premium’. Assuming they should charge students interest (it's economically self-destructive), the premium on today's fixed-rate student loan should be well under 2%.

If you still aren’t sure, chat with your economics prof (or an advisor at your financial institution). But if it was me, I’d reject Canada's over-priced fixed-rate student loans. And I’d tell my friends to do the same.

© Jeannine Mitchell 2013 - 2017