Now that we are all done school, we are now at the point where we need to think about paying down our debt. With on the order of six figures of student loan debt, it’s hard to feel like we’re making any progress towards paying it down. Although we have not been forced into an amortization plan yet by the bank, we have been paying the interest and some principal every month. This will ensure that the principal is at least going down a little. If we only paid the interest every month, the principal would never decrease (although it would decrease in real dollars due to inflation).
We could pay more in principal every month to our loan, and this is not a bad idea. Every dollar paid to the principal is sort of like a dollar contributed into a fixed-income investment which pays interest at the same interest rate as the loan. So paying down principal is like a fixed-income investment. Instead of increasing the principal we pay down every month, we have chosen to maximize our RRSPs first and foremost, which is something I discussed in a previous article. Under the assumption that over the long term our RRSP will achieve a rate of return roughly similar to the loan interest rate, this is a great idea because the return of the RRSP will match the return of the loan (again, treat the loan as a fixed-income investment) but we will also get a bonus: a tax rebate will be generated from the RRSP deductions (because income contributed into an RRSP is tax-deferred).
Since we have made our RRSPs our #1 priority (for the reason mentioned above and described here), we maximized our RRSP contribution room last year and will again maximize our RRSP contribution room this year, at the expense of less principal applied to the loan monthly. In April 2006, we plan to receive a hefty tax refund generated from our RRSP contributions. Since we have already maximized our RRSPs, we do not need to use contribute the tax refund into our RRSPs. Instead we are planning on applying the entire amount against the student loan. This is only possible because we already have an automated savings plan for vacations and other short-term goals, and therefore we do not need the tax refund for any other purpose.
It turns out my parents also used this technique for many years while paying down their mortgage on their home and on a second rental home, allowing them to pay it down faster and become debt-free sooner.