Tuesday, 1 July 2008

HECS/HELP: Pay Now or Later?

I have a HECS debt of $35,091 so far and with the interest of about 3 per cent applied every year (interest is inflation rate as measured by CPI) I was charged a little over $800 in interest. My HECS debt then is ballooning.

One option is to pay everything upfront and get a 10 per cent discount. But is this worth it? According to my calculation that I have done on spreadsheet, if I assume I earn $50,000 forever and if I assume inflation stays at 3 per cent and return on investment is 8 per cent, then for a HECS debt of $35,091 I will pay a stream of income whose net present value is just $22,537. Therefore, it is much better to leave HECS debt and to invest any spare money.

However, what if this is taken to the extreme? Suppose that it is possible for an individual to salary sacrifice into super and therefore lower HECS/HELP repayment income (I don't know whether this is possible, so I'll have to ask an accountant). Once HECS/HELP repayment income is lowered below $39,824 then I no longer have to pay any HECS. I can then invest this money. Would I be better off?

The answer is yes. In 22 years if I just leave my HECS alone then the debt will balloon into a $67,238 debt. However, the compulsory repayments, instead of going to the Government or the ATO, goes into my super fund, which I assume grows at 8 per cent per year. For someone with an income of $50,000 the compulsory repayment rate is 4.5 per cent or $2250. This much money invested in super for 22 years gives $133,149, which is much more than the HECS debt.

This concept is graphed below. Investments in super rise at a much higher rate than the untouched HECS debt, which grows according to inflation. The conclusion is that I should try to defer all HECS debt.

1 comment:

Justin said...

You have not considered risk.
With hecs repyment your 'return' is 10% risk free. Your 8% stock msrket return is risky (volatile) and you can't know for certain what return you will get.
I can't think of many other 10% risk free returns you can get.