Heaping on the HECS debt? Here’s what to do about indexation

The fallout of higher inflation on student loans is about to go through the roof. Here’s what parents or grandparents looking to help need to know.

If parents and grandparents have surplus cash consider helping your children and grandchildren chip away at their HELP loan.

All students at university will soon learn about the concept of inflation and its unpleasant consequences, even if they are not studying an economics or finance degree.

The annual indexation rate on government-funded student loans is about to go through the roof.

Although no interest is charged on the $74bn in student loans that the federal government has provided to three million Australian students, the balance increases each year in line with inflation.

Administered by the ATO, the annual indexation rate on student loans over the past 10 years has averaged 1.97 per cent. But with inflation being a recent economic challenge, the forecast for student loan indexation is 7 per cent. We will know the exact rate when the Bureau of Statistics releases the Consumer Price Index figures on April 26.

The ATO states on its website that “Indexation maintains the real value of the loan by adjusting it in line with changes in the cost of living as measured by the Consumer Price Index”.

Looking at previous years, the student loan indexation rate declared in 1990 was 8 per cent.

So a 7 per cent indexation rate for 2023 is not unprecedented. It is also worth knowing that it swings both ways – students can see a drop in their loan balance in deflationary times.

In 1998, the year after the Asian financial crisis, students enjoyed a 0.1 per cent reduction in their loan balances.

When providing financial planning advice to clients who have High Education Loan Program (HELP) and the older Higher Education Contribution Scheme (HECS) loans, given the indexation rate is generally lower than loan repayment rates and potential investment return rates, making voluntary repayments usually ranks at the bottom of the list of priorities.

In other words, why pay $10,000 off your HELP loan which usually increases at 2 per cent per year, when home-loan interest rates are 5 per cent, investment property loans are 6 per cent, personal loan rates are 10 per cent and credit card rates are 20 per cent.

Similarly on the investment side, rather than pay down a 2 per cent student loan you could invest in high-interest bank accounts at 4.5 per cent or invest in property and share-based investments which historically return 10 per cent per year.

That said, in the past there was an incentive to repay student loans. If a repayment of more than $500 was made, a 10 per cent discount was received. Unfortunately this scheme ended on December 31, 2022.

With the loans provided by the government to undertake further studies which generally increases the student’s income generating prospects, it is no surprise that there are income-based mandatory repayment thresholds.

When you earn over $48,361, you are required to pay 1 per cent of your income towards your student loan balance. The average income earner is required to pay 6 per cent of their income and people on $141,848 and above must pay 10 per cent of their income until they have repaid the student loan.

Mortgage broker and accountant Caxton Pang says: “I advise people not to panic in regard to their HELP loan.

“In addition to the indexation rate being low, most banks do not take into account the student loan when working out maximum borrowing capacity, so in most cases the HELP balance does not affect home loan eligibility.”

It is clear that when the student loan indexation rate is 2 per cent most people will not worry about making extra repayments outside of the mandatory income-based repayments.

But what about when the indexation rate is 7 per cent?

Before you rush out to repay your student loan (which needs to be done by May 31 to avoid the pending 7 per cent indexation), the thing to remember is that inflation appears to be on the way down so this year’s high indexation rate may decline in the near future.

If the indexation rate reverts back towards the long-term average of 2 per cent, redrawing money from your mortgage at 5 per cent to repay a 7 per cent student loan may seem like the right thing to do in 2023 but may produce fewer benefits in the future as the mortgage rate and student loan indexation rate move closer to each other.

It is not unreasonable to expect to see both the inflation rate and home-loan rate around the 4 per cent mark in a year’s time.

One final factor is cashflow: With mandatory repayment rates between 1 to 10 per cent of income, for a graduate in their 20s trying to save money for their first property investment, having around 5 per cent of their income taken by the ATO as HECS repayments is significant and can materially delay their ability to get into the property market.

Now more than ever, if parents and grandparents have surplus cash in their bank account as a result of rising cash and term deposit rates producing more income, spare a thought for your children and grandchildren who would forever be grateful for you chipping away at their HELP loan with a voluntary repayment this year.

James Gerrard is principal and director of planning firm www.financialadvisor.com.au