For the first time, perhaps ever, Australians are considering paying off their HECS loans early.
Now, full disclosure, I paid tertiary debt off early, but, for 99 per cent of the student population, that would be a bad decision.
So, how do you determine whether it makes sense to clear your HECS debt off sooner than later? Let me help you out with that.
The background – HECS explained
HECS loans are government loans given to Australians to help pay for their university degrees.
Technically, the government pays the university directly and then recoups the loan amount from additional income taxes once a graduate begins to earn a certain salary.
Today, almost three million Australians have this kind of debt, with the total amount owing of $76 billion, at an average loan amount of $26,494.
The beauty of the HECS loan program is that the loans are indexed to inflation rather than loaned with an interest rate.
Interest/indexation rate
Over the past 20 years, the HECS loan amount has increased by just 2.7 per cent per annum.
That changed last year when inflation hit 7.1 per cent (and therefore so did the loan indexation).
This year the indexation will be 4.7 per cent.
Hence many Australians are wondering whether to pay back their loans ahead of time to avoid the higher indexation rates.
Inflation is currently at 3.6%, having peaked at 7.8% in December 2022. It’s important to note that you can only repay your HECS loan once. So, imagine paying back $26,494 to save 4.7%, only to realize that inflation (and therefore indexation) sits at just 3% per annum for the next 10 years.
When it DOESN’T make sense
Homeowners will have a mortgage rate that is higher than the rate of indexation. Today, that is north of 6 per cent against the indexation rate of 4.7 per cent.
What’s more, repayments on our mortgage are taken after tax, whereas the HECS repayments come out of pre-tax income.
Even if you don’t own your home, the question is one of opportunity cost. Could you get a better return on your money than the 4.7 per cent rate of indexation?
The answer should be yes.
When it DOES make sense
My HECS debt was the difference between being able to buy another investment property or not.
You see when deciding on whether to lend you the money you need, the banks will look at your net income – the amount you have left after you’ve paid all your taxes and expenses.
The government gets its money back by taking anywhere from 1 per cent to 10 per cent of our taxable income. This is on top of the about 35 per cent in personal income tax the average Australian pays.
For someone earning 50,000, the government takes 1 per cent.
For someone earning $150,000, the government takes 10 per cent.
For me, the 10 per cent was costing me $150,000 in additional borrowings. Which was the difference between being able to get another property or not. This is something your broker/banker can advise you on.
The money in my offset account was saving me 6 per cent – which was more than inflation.
At that time, I felt that the property I wanted to buy could increase by upwards of $50,000 per year, which was twice the average HECS loan balance.
This is the only instance I can think of in which paying back your HECS debt early makes sense.
Other than that, even at 4.7 per cent, it’s cheaper than borrowing money from the bank!
