The Financial Planning Association of Australia The Financial Planning Association of Australia

Should I pay off my HECS debt?

I would be a very wealthy woman indeed if I was paid a dollar for every time I heard the mantra: “HECS is basically an interest free loan, why would I pay it off voluntarily?” And while it’s true that your HECS debt doesn’t accrue an extensive interest bill like a credit card, car loan or even home loan would, it is still accruing interest!

How does HECS work?

It’s in Australia’s best interest to have smart, educated and well-informed workers. That’s why we have HECS (now known as HELP), a government deferred ‘loan’.

If you’ve graduated, you’ll probably notice that each pay period a proportion of additional ‘tax’ is being deducted and directed towards repayment of your HECS loan.  How much you have to repay each pay period is determined by the government and is commensurate with how much you earn.  Presently, the maximum you have to pay is 8% of income per annum if you’re earning more than $100,520.

Should I make additional payments?

If you have other forms of debt that are accruing interest (e.g. credit card debt, a personal or car loan, or even a mortgage) then making additional contributions to your HECS debt on top of what is currently deducted from your pay is unlikely to be a good idea.  That’s because the interest rate on these loans is higher, often significantly so, than your HECS interest rate, which is currently 2.1% for the 2015 year (ATO). So, you would be better off focusing your efforts on paying off those loans.

On the other hand, if you have no other debt and have additional savings, or an ability to save, then you’re likely to benefit from making additional repayments to pay it off much faster than if you were just making your compulsory repayments.

Why would it benefit me?

Say for example you are earning $65,000 a year. You have a HECS debt of $12,000.

Your employer should deduct 4.5% of your salary (at current 2015-16 rates) which is $2,925 per annum as an additional ‘tax’ that’s directed towards your HECS debt.  At this rate, it’s going to take you at least 4 years to pay off your HECS.

Let’s say you are also a good saver and you have $10,000 saved in your bank account, and you continue to add additional savings of $100 per week from your pay. Over the course of the year, depending on how savvy you are with your bank account, you may earn 3% interest on your savings.  Over a year, you would earn a touch over $380 in interest.  Not bad, huh? Pretty good, except the tax man will take his share of tax from this (not so) hard-earned interest; roughly $130, leaving you with a measly $250 in interest to bolster the coffers!  Meanwhile, your HECS debt has accrued $252 of interest at the 2015 indexation rate of 2.1%.  So you’re basically square; you earned an extra $250 in your bank account, but your HECS debt grew by basically the same amount.

Suppose instead that you used your $10,000 in savings to make a voluntary repayment towards your HECS debt before 31 December 2015. By doing this, you forgo the 3% interest rate on your savings in the bank (because it’s no longer there), but you get a ‘bonus’ 5% repayment lodged against your HECS debt.  So for a $10,000 outlay, your HECS decreases by $10,500.  A free $500? Yes please! It would have taken you two years to earn $500 interest on your cash in the bank!

This leaves $1,500 of the original $12,000 HECS debt remaining.  If you keep up your savings rate of $100 per week and use that to pay down your HECS every time you save up $500*, you’ll be HECS free by Christmas!

Once your HECS is fully repaid, you can inform your employer that they no longer need to deduct your HECS repayments from your pay.  This means that an extra $2,925 should be appearing in your bank account every year, rather than going towards your HECS.  If you direct this additional income to your savings account alongside your regular $100 per week, you’ll have your $10,000 savings balance back within 18 months AND be HECS debt free.

*In order to attract the 5% ‘bonus’, you need to make an additional voluntary repayment of $500 or more.

Contribution by Erin Shields, CFP® and winner of the FPA Gwen Fletcher Award, 2014. Erin is a financial advisor at Dixon Advisory & Superannuation Services Limited