If you are at uni and have a bit of spare cash (or your parents do), you might be considering paying your course fees upfront so that you don’t go onto the HELP (previously called HECS) system.
After all, if you pay your course fees upfront you receive a 10% discount. While the HELP upfront discount isn’t as large as it was in the past*, a 10% return on investment isn’t bad, is it?
Also, if you don’t pay upfront, your loan will increase via inflation twice a year.
By paying upfront, you receive a 10% return on your money and you save the inflation that would be charged (assume 3% per year). These factors must make this a ‘no-brainer’ compared to putting your money in the bank.
5% voluntary repayment discount
Also, remember that if you make a voluntary payment to a HELP loan (as opposed to a payment through your tax return if your income is above the threshold), you currently receive a 5% discount.
The power of compounding
But I want to compare this information with the power of compounding interest, as over time the interest may beat inflation.
The big question is, will you be better off:
paying your course fees upfront (and receiving a 10% discount) and not having a HELP debt?
- not paying your HELP debt until later, earning interest on your money and paying before your tax return is lodged?
Basically, will you have more money in your bank account than is required to repay the HELP debt (less any tax you might have paid on the interest in your tax return along the way)?
Let’s work the numbers
Say you owe $5,500 on your course fees and have $5,000 cash which you could use to pay it off now or put in a term deposit.
Pay it off
If you decide to pay off the HELP debt, you would get a 10% discount and the $5,500 debt would become $5,000, which your cash would repay. So you are square from day one.
Pay it off 4 years later
Say you decide to pay off your debt after you finish uni, in 4 years.
Term Deposit – After 4 years, the term deposit of $5,000 should be worth $5,962 (assuming 4.5% interest compounded yearly).
HELP Debt – After 4 years, the $5,500 HELP debt would have risen to $6,190 (assuming a 3% inflation rate). If you repay your HELP debt before lodging your tax return and receive a 5% discount, you could pay $5,881 (being $6,190 x 95%) to clear the HELP debt.
So far so good – you would have $81 after repaying the HELP debt.
Don’t forget tax
However, during the 4 years you would have to pay tax on the interest earned. Even assuming a marginal tax rate of 19%, you would have to pay about $182 tax, so you would be $101 worse off in this example.
The Conclusion: Repaying early just beats earning interest
So after running the numbers, I am forced to conclude that paying course fees upfront (and receiving the 10% upfront discount) is likely to be slightly better than just earning interest (and paying the HELP debt before lodging your tax return to receive a 5% voluntary repayment bonus). Of course, the reason that repaying early came out better was due to paying tax on interest.
Although I still think that repaying your HELP debt needs to be considered within a framework of whether it will be the best future investment for your cash considering other factors.
Other factor #1 – Current credit card debt or the world trip you are planning
Obviously, if you have credit card debt, it might be worth paying off your credit card debt rather than paying HELP debt upfront. Even if you don’t’ have credit card debt, if you are planning a big holiday later on, it might be worth keeping your money to avoid credit card debt later. It might not be worth receiving a 10% discount (plus inflation) if you have to pay 20% per annum interest on your credit card a few years later.
Other factor #2 – Buying a property
It takes a long time to save a deposit to buy a property. Buying a property means that you can live in the property and eventually pay it off.
Saving your cash, or starting a First Home Saver Account, might be a better way to deal with your cash than paying off your HELP debt.
*The previous HELP/HECS upfront discount was 25%, then 20%, and is now 10% as of 1 January 2012.