The Opportunity Cost of Exceeding Minimum OSAP Repayments

When repaying an Ontario Student Assistance Program (OSAP) loan, borrowers face a critical decision: should they pay more than the minimum required amount, or invest those extra funds elsewhere? Understanding the opportunity cost—the potential benefits forgone by choosing one option over another—is essential for making informed financial decisions.

Understanding OSAP Repayment Structure

OSAP loans consist of two components: a federal portion (Canada Student Loan) and a provincial portion (Ontario Student Loan). As of April 1, 2023, the Government of Canada has permanently eliminated interest on all Canada Student Loans, making the federal portion interest-free (0%). However, the Ontario portion continues to accrue interest at a rate of prime rate plus 1%.

The federal portion of OSAP loans is interest-free, while only the Ontario portion accrues interest. This structure allows borrowers to strategically prioritize paying down the interest-bearing portion.

Grace Periods

After completing full-time studies, OSAP provides a six-month grace period before mandatory repayment begins. During this period:

• No payments are required on either portion of the loan
• Interest accrues on the provincial portion at prime rate plus 1% (OSAP Interest Rates )
• The federal portion remains interest-free

The grace period gives graduates time to find employment and establish their financial footing before beginning repayment. However, because interest continues to accrue on the Ontario portion during this time, borrowers who can afford to make payments during the grace period could do so, reducing their total cost of borrowing.

Grace Period Extensions

In certain circumstances, borrowers may be eligible for a six-month extension to their grace period, effectively extending it to one year. Two programs offer this extension: the One-Year OSAP Grace Period for Entrepreneurs for recent graduates who own or co-own an eligible new business in Ontario, and the One-Year OSAP Grace Period for Not-For-Profit Employees for those working at eligible not-for-profit organizations.

Current Interest Rates

The interest rate on the Ontario portion of OSAP loans is calculated as the Bank of Canada prime rate plus 1% (floating rate). The federal portion has no interest (0%). The prime rate fluctuates based on monetary policy, so the effective interest rate on OSAP loans changes over time (OSAP Interest Rates ).

For example, if the prime rate is 2.5%, the OSAP interest rate would be 3.5% (2.5% + 1%). Borrowers can check the current prime rate on the Bank of Canada Daily Digest and add 1% to determine the current OSAP interest rate. Note: Prime rates fluctuate based on monetary policy, so the example rate used here is for illustration purposes only.

The federal portion of the loan remains interest-free (0%), meaning borrowers only pay interest on the Ontario portion.

Paying Off the Provincial Portion Independently

One strategic advantage of OSAP’s two-part structure is that borrowers can pay off the interest-bearing Ontario portion independently from the federal portion.

How to Direct Payments to the Provincial Portion

To direct a one-time payment specifically to the Ontario (provincial) portion of a loan, follow these steps:

1. Ensure the loan is in good standing - The loan must be current and not in arrears, and regular payments must be up-to-date.

2. Make an additional payment - Make an extra payment toward the loan. This payment is in addition to the regular monthly payment and does not replace it.

3. Submit a Direction Request - Log in to the NSLSC account and navigate to the “My Requests” section. Select “Directed Loan Payments” and specify that the payment should be applied to the provincial portion of the loan.

4. Timing requirement - Payment must be received within 10 business days of submitting the direction request.

Alternative method: If the NSLSC account cannot be accessed online, borrowers can mail a cheque payable to the NSLSC along with a written request specifying that the payment should be applied to the provincial portion. Include the loan number on both the letter and cheque. For the mailing address and contact information, visit the NSLSC contact page .

Benefits of Keeping the Loan

Maintaining a student loan balance rather than aggressively paying it off offers two significant benefits that function as financial protection and effective interest reduction.

1. Free Insurance Against Hardship and Disability

OSAP loans include built-in protection programs that function as free insurance against financial hardship and disability.

• Repayment Assistance Plan (RAP): Reduces or suspends payments for borrowers facing financial difficulty, and can extend repayment up to 15 years with potential debt forgiveness.
• Severe Permanent Disability Benefit: Can cancel loans entirely for borrowers who develop a severe permanent disability (NSLSC - Severe Permanent Disability Benefit ).

By maintaining minimum repayments, borrowers preserve access to these protections, while paying off loans early forfeits this insurance-like safety net.

2. Tax Credits Reduce The Effective Interest Rate

Interest paid on student loans is eligible for a 15% federal non-refundable tax credit, effectively reducing the interest rate. The tax credit reduces the after-tax cost of borrowing by 15%, meaning the effective interest rate is calculated as: interest rate × (1 - 0.15) = interest rate × 0.85.

For example, a 3.5% interest rate effectively becomes 2.98% (3.5% × 0.85 = 2.975%) after accounting for the tax credit. This credit can be carried forward for up to five years if not used immediately.

Comparison: Extra Payments vs. Investing in a 4% GIC

To illustrate the opportunity cost, consider a scenario with a $30,000 OSAP loan ($15,000 federal at 0%, $15,000 provincial at 3.5%) and a 14.5-year term. The borrower has an extra $200 per month to either pay down the debt faster or invest in a GIC earning 4% (assuming a Tax-Free Savings Account).

*Net Financial Position represents the total amount accumulated after accounting for all payments made, interest paid on the loan, interest earned on investments, and tax benefits received. This metric shows the borrower’s overall financial outcome at the end of the loan term.

**Assuming the borrower invests the freed-up cash flow after the loan is paid off at 4% GIC for the remaining term.

In this example, investing in a 4% GIC results in a net financial benefit of approximately $942 more than making extra payments. This demonstrates that when the investment return (4%) exceeds the effective interest rate of the loan (~3% after tax credits), investing is the mathematically superior choice.

Important Considerations

Before choosing a strategy, borrowers should consider:

• Curent Rates If GIC rates fall below the effective interest rate on the loan (approximately 3% after tax credits), making extra payments becomes the better financial choice. If the prime rate rises significantly, the OSAP interest rate will increase accordingly.

• TFSA Contribution Limits If investing in a TFSA, ensure sufficient contribution room. For investments outside a TFSA, interest income is taxable, reducing the effective return.

Maximum Repayment Term

The standard repayment term for OSAP loans is 9.5 years. However, borrowers have the option to extend the repayment period up to 14.5 years to reduce monthly payments. Extending the term:

• Lowers monthly payment amounts, making repayment more manageable
• Increases total interest paid over the life of the loan
• Provides flexibility for borrowers with limited cash flow

Borrowers should consider extending the repayment term, as the effective interest rate after accounting for the interest-free federal portion and the 15% tax credit on interest paid is typically favorable. Once the provincial portion is paid off, the remaining federal portion is completely interest-free, making the extended term even more advantageous. The lower monthly payments provide greater financial flexibility while maintaining access to the tax benefits and protection programs associated with student loans.

Conclusion

Deciding whether to exceed minimum OSAP repayments requires careful consideration of multiple factors, including current interest rates, tax implications, personal financial goals, and risk tolerance. When the prime rate is relatively low (for example, around 2.5%), the effective cost of borrowing after tax credits is typically around 3% or less. While making extra payments reduces debt faster, investing those funds in a higher-yield vehicle like a 4% GIC (especially in a TFSA) may yield higher net returns, assuming the investment return exceeds the effective interest rate on the loan.

Borrowers should also consider:

• Prioritizing the Ontario portion if making extra payments, since it’s the only interest-bearing component
• Taking advantage of tax credits on student loan interest
• Understanding insurance protection - maintaining loans preserves access to RAP and disability benefits, which function as free insurance against hardship
• Maintaining an emergency fund before accelerating debt repayment
• Consulting with a financial advisor to develop a personalized strategy

The optimal strategy depends on individual circumstances, but understanding the opportunity cost helps borrowers make informed decisions that align with their long-term financial goals.