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tax matters

I've got a close friend, Johnny, who has got to be the world's best debt-collection specialist. It's a tough job, and you need a thick skin to do it well. "The secret to my success," he told me, " is that I'll tell a debtor that if they don't pay up, I'll approach their other creditors and tell them that I collected my money." There you have it: The psychology of collecting on debts.

Speaking of debt collection, I want to talk about student debt. As thousands of students head back to colleges and universities, many are accumulating more debt with every semester that passes. This isn't necessarily a bad thing, but students should keep a few things in mind when borrowing for an education.

The trend

There has been greater focus and discussion about student debt the past few years. Between 1989 and 2009, average tuition fees paid by students as a percentage of total revenues for universities and colleges more than doubled, rising from 10 to 21 per cent, while funding from government fell from 72 to 55 per cent, according to research published by Statistics Canada (see "The Financial Impact of Student Loans," published in January, 2010, available at

The article examined those between ages 25 and 45 who had taken out student loans for postsecondary education. For the most part, student debt has been worth the borrowing because those with post-secondary education have earned, on average, much higher incomes than those without. Having said this, those respondents who borrowed for education, perhaps not surprisingly, were less likely to purchase a home and accumulate other investments – pretty common elements of financial security.

So, debt is okay, to a point. The average debt of students at graduation, based on the most recent study available, was $18,800. Only 17 per cent of students had paid off their loans by graduation, with the average taking just over seven years to pay off those loans. A full 27 per cent of those students owed more than $25,000 at graduation, and 6 per cent owed more than $50,000. How much debt is enough? After all, you don't want Johnny calling to collect when payments are missed.

The rule

I've said this before, but a prudent student will cap the amount he borrows to pay for postsecondary education at a level that is related to the income he expects to earn later. The rule I like to use is called the "Rule of Tens." Here's how it works: For every $10,000 in student debt, the student should be able to earn $10,000 over a base income of $10,000, to be able to pay off that debt in 10 years.

For example, if a student graduates with $30,000 of debt, he ought to earn $30,000 per year over a base of $10,000, for a total of $40,000 per year, in order to pay off that debt within 10 years. In this example, a $30,000 loan amortized over 10 years at an interest rate of 5 per cent would result in payments of $318 per month, or about 11 per cent of after-tax take-home pay for someone earning $40,000 annually. That should be manageable.

So, all of this raises the question: How much will a student be able to earn when he graduates? It should be clear that some programs of study will result in higher incomes than others, and therefore might justify higher levels of student debt. Be realistic here.

The nuances

If a student is going to borrow money for education, then it makes sense to get some tax relief for the interest costs, if possible. A tax credit is available for interest costs on student loans as long as the loans qualify under the Canada Student Loans Act or similar provincial legislation. So, borrowing from family members who charge interest, for example, won't provide this tax relief.

If a student does happen to have loans that qualify for the interest tax credit, this is the type of debt that should be paid off last. Don't get me wrong, paying off the debt is a good thing, but if the student has high-interest credit card debt, for example, he'd be wise to pay that off first given the tax relief available on the student-loan interest.

More on funding an education next time.

Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.