Again with something different today I’d like to hand the microphone over to another seasoned Aussie blogger out at Wealthy Winters. Mrs Winter, her husband and children post regular helpful and Australian based finance pieces on how to do it right despite their numerous setbacks. With a tail that makes most “Aussie battler” lifestyles sound down right easy in comparison (ours included) it’s obvious she’s a secret Mortgage Mutilator when you see some of the similarities between our two sites (eg. no damn TV’s people!). So here we go, take it away Mrs W!
Now that HECS/HELP debts are changing from CPI indexation to that of the Treasury 10-year bond rate, you may wonder whether it’s worth paying off your debt sooner, or how the changes are going to affect you long-term. Instead of vague mumbo-jumbo about indexes and repayment rates, I’m going to help you clearly calculate whether paying off your debt sooner is worth it.
Let’s start by clarifying the changes. If you’re not sure of the difference between HECS-HELP (which I’ll just call HECS) and other HELP debts, check out this site here.
- I’m going to assume you have a HECS debt, although the changes are similar for most of the HELP debts (it’s just the HECS has been around longer and applies to most people).
- From 2016-17, the new threshold before you have to start repaying your HELP is $50,638 instead of $51,309. This isn’t as bad as it seems; if you look here, you’ll see that the repayment threshold has gone UP about $2,000 per year each financial year – so this is only a small step backwards that only makes a small difference to most people
- At this point, despite proposed legislation, you still currently get 5% bonus of repayments over $500 i.e if you pay $500, you’ll have $525 deducted from your loan.
- Repayments for the loan were previously calculated based on the CPI (Consumer Price Index) which is the change over time of a selection of certain grocery items. From 1 June, 2016, they will instead by indexed by the Treasury 10 year bond rate up to a maximum of 6% per annum
- Indexation is applied on the first of June each year, for debts older than 11 months
- Science @ Melbourne Uni currently $8,613 per year for full-time students, multiplied by 3 years comes to almost $26,000. We’ll use that for our estimates, assuming you’ve not paid down any of your HECS.
The Treasury 10-year bond rate is not drastically different to the current indexation, as some people have made it out to be – over the last 5 year, you would have seen a difference in between 0.14 and 3.65 percentage points. While the latter isn’t great, it’s not the same as going from 0% to 6% as it may seem.
It’s important to note than unlike most debts you incur, your HELP debt is indexed annually, not monthly or weekly, meaning that the balance increases due to being indexed only once per year. This means you do not pay “interest on interest” over the course of the year.
Repaying your HECS-HELP with minimum repayments
To make this a little clearer, here is an example. For the purpose of simplicity, I have assumed no bonus from the government – this has been decreasing over time, anyway, and it seems like it is likely to disappear within the next few years.
I have also assumed that more than 11 months have elapsed since any debt was incurred, and that the person paying the debt is earning just enough to have to make repayments. On a salary of $53,346 per annum, they will be obliged to repay 2% of their salary ($2,133.84). Despite the fact this threshold doesn’t increase until 2016, it’s easier to calculate from today. The fact that this is paid monthly is irrelevant as the balance is indexed annually. Finally, I cannot know what future bond prices will be, so I will take a worst-case scenario and set the indexation at 6%.
It takes 23 years and $24,926.90 dollars to pay off your HECS debt – and yes, obviously part of this takes into account inflation (which you could say on average sits at 3%), so discounting inflation you’d be paying roughly $12,000 over 23 years, or $521 per year.
Now let’s imagine you’re in a higher income bracket, earning $74,107 per annum. This means your repayments will be at 6% of your income, or $4,446.36 per year.
Here, the repayment period drops to 13 years and the cost drops to $14,300 – only $7,000 if you discount inflation, or $538 per year.
From this, you can see that of course delaying paying off your HECS sooner costs you money – but on average, it’s not that much – about $45 per month. While it’s great to get rid of debt, you have to remember that over time your wage will also increase, as will your payments, so you will forced to pay it off later.
Repaying your HECS if you’re not working
For those concerned that they don’t earn an income, the situation is a little different – after all, if you’re not making repayments, your debt is only growing, so that if you return to work later, you’ll have an even larger debt to knock down.
First of all, don’t forget that roughly half the “cost” of this debt is inflation – meaning that relative to your income and other goods you might buy, you’re not paying as much as it seems. As I mentioned earlier, this difference comes down to between 0.14 and 3.65 percentage points. Still, 3.65% on a debt you’re not paying anything on can add up, and unless you’re never going to work (your HELP debt is cancelled upon death), it may be worth paying a nominal amount towards it per year.
Something that people forget, though, is that if the market is strong, you are quite likely to be better off just investing that money elsewhere and then paying back HECS when you have to – compare the previous year’s indexation rate to what you can get at market, and deliberately put the money aside to cover for future years.
In this way, you put money into investments now, and get returns from now into the future. When you go back to work and need to pay your HECS, your income will be reduced by the minimum repayment, which is money you can’t put into investing, but the money you previously invested has been compounded and growing all the time in between.
Let me rephrase. If you pay your HECS off now, you’re decreasing the effective “interest” on the loan (the indexation) by a certain amount, but because your investments would yield a higher rate of return, you would actually have more money overall if you just invested the money. Moreover, if this occurs over 5 years, your debt may have increased by 5%, but your investments may have increased by 10-15% (total) – and any loss in income in the future caused by HECS repayments is offset by the wonder of compound interest.
So in general …
You are almost always going to get a better return on your money investing it rather than paying your HECS off early. The maximum rate – 6% per annum – will only occur in times of strong markets, and therefore you’ll almost certainly be able to invest or even save your money in a high-interest account with better results. Don’t forget, if you’re saving the money at a high interest rate, your interest is paid monthly and compounds over the year, whereas your HELP debt is only indexed annually.
If you have the extra money, saving it for yourself and then paying the compulsory payments is generally going to be the most efficient option for most people.
How this can make your winters wealthy:
- While HELP debts are really just a background debt, and not relevant for low- or non-income earners, they will still creep up when you’re not paying them and will take a cut from your pay packet as long as you’re earning over the minimum threshold. If you aren’t paying anything into your HELP debt and expect to go back to work at some point, it may be a good idea to pay enough to cover the indexation each year
- For those who are working, paying extra off your debt is nice, but won’t make a huge difference given your natural wage increase and other inflation over time. If it makes you feel better, then go ahead, but it’s not something you should worry about. If you’re in the higher income brackets, you definitely don’t need to worry about it. Save and invest instead.
The benefits include: 1) How to pay off your mortgage faster than 99% of people with one hour a month of work 2) How to get rid of your debt and have the freedom to spend money on the things you love, guilt free 3) Clear outline of how to setup your expenses, mortgage and general finance 4) How offset accounts work and how to get the same result without being gouged by the big banks 5) How to cut through the crap and focus on the things that truly matter when taking down a mortgage 6) How to adjust the strategy so it works for you, even if you have kids, even if you only have one income 7) How to do all of these things and maintain a normal social life (and never be cheap).