Is it worth making early repayments of student loans?

ONE of the earliest debts many young people take on is to pay for university. If there is such a thing as good debt, this one fits the bill — education generally leads to higher lifetime earnings.

Most people who borrow to fund university studies do so using the Federal Government’s Higher Education Loan Program, called HELP, previously known as HECS.

This education debt is likely to be your cheapest debt, indexed annually at the rate of inflation. For 2016, that rate is 1.5 per cent.

Financial planners generally advise students are likely to come out ahead by directing any savings into a high-interest savings account or term deposit rather than repaying the debt early.

To be in a better financial position, you need those savings to earn more than 1.5 per cent after tax.

That means that if you join the workforce and pay a marginal tax rate of 32.5 per cent — meaning you earn between $37,000 and $80,000 a year — your savings would need to attract a 2.23 per cent rate to grow faster than your student debt.

Some online savings accounts offer introductory rates of 3 per cent while one-year term deposits are being offered at 2.6 per cent. If ex-students can invest their money at a rate that grows faster than indexation that applies to their HELP debt, they would be better served to invest their money and have it grow quicker than the debt is growing. Once their funds have surpassed the debt, one could choose to pay it all off.

It is worth noting that out you cannot get a HELP payment back, but you have access to your savings in a term deposit — albeit on the terms set out by the bank.

And when it comes to paying off debt, the basic rule is that you start with the most expensive after-tax debt.

From a purely financial standpoint, if you can earn a better return on your savings than the HELP indexation rate, you’re probably better paying down the loan through compulsory repayments each year.

But if it’s hanging over you and there’s peace of mind to be gained by paying it off early, well, you can’t put a price on that.

https://www.moneysmart.gov.au/life-events-and-you/under-25s/studying/paying-off-your-uni-debt

– John Dage