Paying Interest vs. Paying Off Principal

[the.milky.way]

I was recently approved for an LOC with Scotia and have had to make withdrawals for basic living expenses due to a crappy pay schedule at my workplace. I was wondering whether, when I get paid, I should pay off as much of the credit I borrowed as soon as possible or let that accumulate and only pay off the interest each month?

 

Math was never my strongest area so I am a little confused - if I pay off the interest every month and the principal is still owed, isn't a new interest just calculated off the previous principal and the the principal from the present month? What is the point of making only interest payments? Granted, if I don't pay off the balance I've used I can save that money and make interest only payments for longer but why not pay off the principal instead?

 

Any help would be massively appreciated - thank you!

[Renoir]

you must pay your monthly interest. That is all that's required of you. Heck, you can even do some creative bankwork to pay your interest payment out of your principal.

 

However, paying off principal is always a good idea, and it should be a habit while working. Whatever accounts you have, pay off those that have the highest interest rate first (ex. always pay off credit cards before LOC principal, even if it means withdrawing from your LOC) I met far too many students financing school via credit card -scary!

 

Remember, the basic thing to think about is: where will I lose the lowest amount of money possible depending on which account I put it in? Generally, you are making very little interest in your savings account (far lower than the 3% your LOC principal is charging you), so you're better off shifting it back to the LOC.

[Boo_The_Monster]

Its my understanding that this Scotia plan simply adds the interest to the balance owed such that the total available credit is reduced.

 

I'm just wondering why one would make interest only payments instead of paying off the principal - if the interest is paid off each month but the principal remains, interest is still calculated on the full amount. I suppose I'm wondering, how does paying off the accumulating monthly interest help with the fact the interest will compound?

[cheech10]

Interest can't compound if it doesn't accumulate. Paying off the interest every month leaves you owing the principal only. Not paying off the interest adds that month's interest to the principal, which leads to larger (compound) interest in future months.

 

You don't really pick what your payment is applied to, interest or principal. It first goes to pay off that month's interest, and any leftover pays down the principal.

 

I'm not sure if that answers your question, your post was a bit vague.

[Renoir]

The longer you carry any debt, the more it costs you.

 

That being said (and not trying to be contradictory here because it's such a true statement), there IS something to the idea of amortization (long term payments) being easier to pay off in the end if inflation is steady over the years. But that's a pretty academic thing to mention given today's marketplace.

[rmorelan]

That being said (and not trying to be contradictory here because it's such a true statement), there IS something to the idea of amortization (long term payments) being easier to pay off in the end if inflation is steady over the years. But that's a pretty academic thing to mention given today's marketplace.

 

and some tax benefits to not radically attempting to pay it off either too quickly. That only works because in Canada we have a marginal tax system (or have different tax brackets) and as medical professionals we can control out much we personally make each year vs leaving income in our corporations.

 

Usually we just say unpaid interest is added to the principal to create a new higher principal total for next year.

 

there is absolutely no reason to have any cash saving if you have an LOC in use. The only advantage to cash in a chequing or savings account is ease of use, but the LOC is just as easy. The rate of return in the savings accounts etc is no where near the interest on the LOC (and you would even get taxed on the interest in yours savings making it even lower).

[amichel]

and some tax benefits to not radically attempting to pay it off either too quickly. That only works because in Canada we have a marginal tax system (or have different tax brackets) and as medical professionals we can control out much we personally make each year vs leaving income in our corporations.

 

Usually we just say unpaid interest is added to the principal to create a new higher principal total for next year.

 

there is absolutely no reason to have any cash saving if you have an LOC in use. The only advantage to cash in a chequing or savings account is ease of use, but the LOC is just as easy. The rate of return in the savings accounts etc is no where near the interest on the LOC (and you would even get taxed on the interest in yours savings making it even lower).

 

 

I have savings in an RESP that is making more in interest than the LOC charges in interest. So I'm not going to use it all quite yet.

[Renoir]

I have savings in an RESP that is making more in interest than the LOC charges in interest. So I'm not going to use it all quite yet.

 

That's legit. I have a small amount of RRSP in mutuals doing the same.

 

I remember the World Financial Group people trying to convince me to "reinvest" my LOC debt into medium-risk stuff. I hope noone here gets suckered into that...

[rmorelan]

I have savings in an RESP that is making more in interest than the LOC charges in interest. So I'm not going to use it all quite yet.

 

well that is useful Of course that is a tax sheltered investment vehicle.

[the.milky.way]

It might be more useful if I post some numbers related to my particular situation:

 

At the end of the summer, let's say September 2nd, I will have about 3000 from the staggered pay of my job. I expect that with buying furniture, living expenses, clothes, etc, I'll be close to 5000 on my LOC.

 

I am not typically a person who shops a lot so I am not concerned about the fact that I'll be spending that money earlier on. I haven't bought new clothes for over 3 years because I lost a lot of weight getting back in shape, I don't have furniture for my new place, and I'm not getting paid on time so I have to make deductions from my LOC to meet basic living expenses.

 

After this summer, I will have no more cash flowing in to keep up principal payments so I'll have to let the principal accumulate. I was thinking that I could stretch that 3000 to keep paying off monthly interest for about two years though.

 

Any advice?

[rmorelan]

It might be more useful if I post some numbers related to my particular situation:

 

At the end of the summer, let's say September 2nd, I will have about 3000 from the staggered pay of my job. I expect that with buying furniture, living expenses, clothes, etc, I'll be close to 5000 on my LOC.

 

I am not typically a person who shops a lot so I am not concerned about the fact that I'll be spending that money earlier on. I haven't bought new clothes for over 3 years because I lost a lot of weight getting back in shape, I don't have furniture for my new place, and I'm not getting paid on time so I have to make deductions from my LOC to meet basic living expenses.

 

After this summer, I will have no more cash flowing in to keep up principal payments so I'll have to let the principal accumulate. I was thinking that I could stretch that 3000 to keep paying off monthly interest for about two years though.

 

Any advice?

 

If I understand you correctly:

 

you should just use whatever income you obtain to immediately pay off as much of the loan as possible when ever it arrives, and then continue from that point onward to use the LOC with further interest payments be simply added to the principle.

 

that will simply put result in the lowest overall cost to you. You don't gain any advantage by making money payments (unlike a regular standard loan - this one doesn't have repayment terms, such that not paying the interest would hurt you in some way).

[Renoir]

I expect that with buying furniture, living expenses, clothes, etc, I'll be close to 5000 on my LOC.

 

Any advice?

 

Totally not "financial advice", but, I suggest building your own furninture!!

 

I love getting random stuff and putting it together to make cheap and useful furniture. Ikea as-is section has some cheapish tabletops and other items that can help in designing your own stuff as well as Habitat for Humanity restores (used/extra materials).

 

That is, if you have time

[the.milky.way]

I was actually thinking of building my own desk - problem is that I know little to nothing about furniture assembly or carpentry, but I suppose there's a first time for everything.

 

I'm a fairly short person who has problems with desks being too high. Instead of dumping a ton of money on a height adjustable desk (thought that would solve many problems), I figured I could just build a desk. However, I won't be back in time to build it for the start of school so I'm not quite sure at this point.

 

The other furniture I'm looking for is all wood so that it can last a long time. My previous set was all Ikea furniture, specifically the particleboard kind, which was generally a terrible idea.

[amichel]

I was actually thinking of building my own desk - problem is that I know little to nothing about furniture assembly or carpentry, but I suppose there's a first time for everything.

 

I'm a fairly short person who has problems with desks being too high. Instead of dumping a ton of money on a height adjustable desk (thought that would solve many problems), I figured I could just build a desk. However, I won't be back in time to build it for the start of school so I'm not quite sure at this point.

 

The other furniture I'm looking for is all wood so that it can last a long time. My previous set was all Ikea furniture, specifically the particleboard kind, which was generally a terrible idea.

 

The ikea wood stuff (as opposed to particle board) is actually pretty nice and lasts for ever. The Hemnes stuff specifically. Pretty cheap too, although not as cheap as the particleboard stuff.

[No1Dr.Ozfan]

 

I remember the World Financial Group people trying to convince me to "reinvest" my LOC debt into medium-risk stuff. I hope noone here gets suckered into that...

 

what about investing student loans? Alberta student loans continue to have 0% interest during residency, so assuming a minimum of 6 years interest free (more for residencies other than family), that gives you a fair amount of time to get small return on some 'safeish' investments.

[DarkGhost]

what about investing student loans? Alberta student loans continue to have 0% interest during residency, so assuming a minimum of 6 years interest free (more for residencies other than family), that gives you a fair amount of time to get small return on some 'safeish' investments.

 

My initial response to this was to shake my head, because years of investing in stocks and mutual funds has taught me that not only can you lose lots of money when you're paying attention, but if you're not staying on top of it, you could lose everything... And then some, if you decide to bear the market. So, the only investing I would go near if you have no experience is short-term GICs or low risk mutual funds. However, you still risk losing money, which likely isn't worth it unless you can still be comfortable with those loses. However, a cash investment account may also be worth looking into if you want a little more interest, but your safest bet is going to be a simple savings account.

[rmorelan]

Is your amount of Alberta loans not affected by your assets? Holding investments when trying to get student loans is usually dangerous

[DarkGhost]

Deleted...

[No1Dr.Ozfan]

Is your amount of Alberta loans not affected by your assets? Holding investments when trying to get student loans is usually dangerous

 

It is, but wouldn't assets be calculated by subtracting debt from your total assets? So if I put 20K of student loans in a TFSA to invest, I'd have essentially 0 assets because the money is loaned? Intuitively, if I have a wad of cash that is loaned to me, I don't think of it as an asset because it's debt that I have to repay. But I guess the government might think otherwise. I'd also be in the red on my LOC, but nowhere near the max.

 

If I did put money into the market, it would be in ETF's tracking index's.

[rmorelan]

It is, but wouldn't assets be calculated by subtracting debt from your total assets? So if I put 20K of student loans in a TFSA to invest, I'd have essentially 0 assets because the money is loaned? Intuitively, if I have a wad of cash that is loaned to me, I don't think of it as an asset because it's debt that I have to repay. But I guess the government might think otherwise. I'd also be in the red on my LOC, but nowhere near the max.

 

If I did put money into the market, it would be in ETF's tracking index's.

 

often not actually - that is the problem. also why I was asking about specifically Alberta.

 

These government loans fall under a kind of social assistance type model often, and in social assistance you aren't allowed to receive payments when you have assets you can use instead to pay your bills. In OSAP for instance there is absolutely no consideration of debit but your assets are considered in spades. If you own a car you lose money. Actually if you even lease a car you lose money. If you have investments, cash you lose money. If you even have income where the government thinks you should have saved and therefore have assets you lose. Pretty obvious pattern there!

 

that is why for Ontario in particular holding any investments is not logical if you are a medical student unless something special is going on. You automatically lose on the OSAP grant (7K a year times say 4 years), you have to pay tax potentially on the investments, and you like get nailed again because any bursary application again considers your assets and whether you qualified for full OSAP. Exceptions include a small amount of RRSP and also your primary residence for OSAP.

 

I was very careful to structure my financial matters in medical school to max out the amounts of money I was receiving. The result was 10s of thousands of dollars in the end so being careful is not a bad idea I think

[No1Dr.Ozfan]

often not actually - that is the problem. also why I was asking about specifically Alberta.

 

These government loans fall under a kind of social assistance type model often, and in social assistance you aren't allowed to receive payments when you have assets you can use instead to pay your bills. In OSAP for instance there is absolutely no consideration of debit but your assets are considered in spades. If you own a car you lose money. Actually if you even lease a car you lose money. If you have investments, cash you lose money. If you even have income where the government things you should have saved and therefore have assets you lose. Pretty obvious pattern there!

 

that is why for Ontario in particular holding any investments is not logical if you are a medical student unless something special is going on. You automatically lose on the OSAP grant (7K a year times say 4 years), you have to pay tax potentially on the investments, and you like get nailed again because any bursary application again considers your assets and whether you qualified for full OSAP. Exceptions include a small amount of RRSP and also your primary residence for OSAP.

 

I was very careful to structure my financial matters in medical school to max out the amounts of money I was receiving. The result was 10s of thousands of dollars in the end so being careful is not a bad idea I think

 

you are a cool dude. thanks!

[LostLamb]

I think it is very very similar for AB student loans...not worth having investment as it will count against you for both loan limit, low income grants, possibility of applying for differential tuition bursary, possibility of receiving school bursaries based on financial need.

 

Although...pretty sure I was not penalized for owning/leasing a car. But I know I would have lost out otherwise if I had extra funds floating around available for my use.

 

JMHO. I am certainly NOT a financial expert!