In starting work on a paper about the student loans scheme, one thing I wanted to investigate was a finding of a survey of first-year students (pp.71-72) that a significant minority – ranging from 23% of those aged over 25 to 38% of 19 year olds – work while studying ‘to save for repaying future HECS-HELP or FEE-HELP debts’.

I wasn’t sure that this would be the right financial strategy for students with cash to spare while studying. The apparent incentive in the HECS-HELP scheme is to pay on enrolment. If a student pays at least $500 upfront, he or she will get a ‘bonus’ of 25% on the amount paid. In one of the examples I use below, an Arts student with an annual charge of $5,310 who paid $2,000 upfront would have $2,500 wiped from their balance, leaving $2,810 to be paid off through the tax system.

If a student makes a later voluntary repayment using their savings they get a bonus of 10%. For example, once they already had a debt they could pay $2,000 and get $2,200 taken off their balance. Could the benefits of saving the money and accruing interest compensate for the bonus shrinking from 25% to 10%?

Somewhat to my surprise, on the examples I used of male graduates in arts and law and the assumptions I made (details below for those interested) the two options are roughly equivalent. With 5% interest the interest accrued on the saved money plus the bonus can match the original bonus. Either lead to a lower total payment than deferring the cost of the course’s full sticker price.

The saving now to pay later option has the advantage for the student that it gives them ‘ rainy day’ money they can use for something else if they need to. On the other hand, the availability of the money creates temptations to spend it on non-essential items, so they may end up on a more expensive repayment schedule.

*Assumptions*

The examples I used were male graduates in arts and law, in professional or managerial occupations. I assumed that they started university when they were 18, and entered the workforce when they were 21 (a bit unrealistic for law students, as most do double degrees). However this simplifying assumption lets me use census income data by age groups.

I based my income assumption on the mid-point of the median 2006 census income category. Given earnings dispersion, using the first or third quartile would lead to quite different repayment patterns. I inflated census incomes by the increase in average weekly earnings, though on reflection the labour price index would have been better. But we are inevitably creating a rough guide here.

I assumed inflation of 2.5% a year, which is then used to index the student’s debt. For students working now to pay for their education, I assumed that they had the option of either paying $2,000 upfront at the beginning of each year of a three year course, or investing that $2,000 in an account paying 5% a year interest.

For the investing students, I assumed that they would repay via the tax system until the accumulated amount in their bank account plus the 10% bonus was equivalent to their remaining debt, at which point they would pay off the remainder of their debt in a lump sum. They would not repay earlier, because they are effectively borrowing from the goverment at 2.5% a year and lending to their bank at 5% a year. In the years when they are paying income tax, I reduced the interest by the relevant amount. That effectively reduces the interest received to about 3.5% a year.

not paying up front also lets you smooth your income. for a lot of people the value of the cash is worth more than the 5% the bank will offer you.

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wow, really interesting. It’s a shame there was no option to compare paying it all up front vs. interest gained by saving the money and paying it off from tax.

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If a student invested the annual fee discounted at 5% interest at the beginning of each year and withdrew the total amount at the start of the fourth year (ie, when they had completed) the Arts student would earn $1,100 in interest and the law student would earn $1,900. As the discounts for paying upfront are $3,200 and $5,300 respectively, they are clearly better off paying upfront. On the same basis as the calculations above, the student completely owns an Arts degree for $13,900, and a law degree for $23,100.

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I always suspected that this was the case, thanks for bothering to work it out! I guess this works out more in favour of deferral if people can keep that money in the bank while they’re working overseas or earning under the threshold (eg. caring for children). It’s unfortunate for the students who can’t do either – ie those who have to use the money for living costs.

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Old news guys.

Bruce Chapman – Professor of Eco from the RSSS at ANU and designer of the HECS system openly (ok quietly) admits that it is better not to take the 25% upfront discount and to hold out.

You’ve got most of the assumptions right, but you’ve missed some key points. That its, a good 15% of total HECS debt never gets repaid. NEVER!

So why is that?

Well if you don’t pay tax, you aint payin your HECS. In other words, if you’re havin a baby, travelen the world or just plain dodgy, you aint paying your HECS. And the longer its takes for you to repay, the bigger the interest rate subsidy and therefore, the bigger the effective discount.

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Baz -Whether it is better to hold out depends on your personal circumstances. In the examples I picked of financially successful graduates who will repay fairly quickly it is better to pay some or all upfront and get the bonus (or take the discount, depending on how you look at it). This is because the bonus exceeds the interest they could earn on the money that could be used to pay fees.

If you are unlikely to ever repay, then obviously the incentive is to not pay upfront. When for example I applied my model to all female graduates from language and literature courses at their median earnings they would never repay anything.

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A few years ago, I did the calculations for a five year degree and not working for one year in the first five years out of university (eg, for further study, travel overseas, parenthood) and in that situation you are better off deferring.

I object to the 25 per cent discount for paying upfront on the basis that it is rewarding those people who(se parents) can pay for their degree at the time of enrolling. Aren’t they already better off? Why help them out? Is it really worth that much to the government to get the money now?

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Sam – The purpose isn’t to help them out. If you are better off by deferring, someone else is worse off – ie, the Australian taxpayer. Carrying the HELP debt is costing taxpayers $650 million a year and increasing, before we even get to the problem of those who never repay. On average it will save taxpayers money if they can avoid carrying debt.

BTW, the discount is 20%, but that is equivalent to a 25% bonus. Eg say the fee is $10,000. A 20% discount makes it $8,000. But that $2,000 is 25% of $8,000, so upfront payments get a bonus of 25%.

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The children of law and accounting firm partners all pay up front, or rather, their parents (read: fathers) pay. Why is it so? Because they are the recipients of income from their family trust. (The parents’ income is paid into the trust and then distributed to family members on lower tax rates.) Because of this, the students reach the HECS income repayment threshold while they are still students. (Not that they see any of this income, but as far as the tax office is concerned, they are getting it). So they might as well pay the fees upfront and get the 20%. Putting it on HECS has no deferral value at all.

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Andrew – if those not that don’t pay back their HECS-HELP (for whatever reason) are a “problem” I look forward to your analysis of taxpayer ROI for sports and the arts…

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Jaeger – Students taking higher education courses in sport and art do pay a contribution to their courses and repay via HELP if needed.

In principle I support all post-secontary students making a contribution with a loans scheme, though this should be part of a coherent policy for non-higher education students rather than an ad hoc singling out of particular institutions, as has happened to AIS many times over the years.

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Andrew, I seem to be missing something. I presume the point of the comparison is to find the sum of nominal cash outflows required for a student to reach a zero net debt position. If so, why do you add “interest forgone” to the pay upfront option? By contrast, if you are saving to pay back later then whatever interest you earn is used to pay off the debt, so you are not ending up with any interest in your pocket – ie there is no interest forgone in paying upfront.

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Rajat – I included the interest forgone separately because I was unsure of my thinking here. In the choice between paying upfront and investing at 5% pa I thought not getting the 5% pa was an opportunity cost. But I think you are right – the opportunity cost would exist compared to not going to uni but not in this comparison.

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One thing you could do is discount payments after year 1 by the CPI so that the total cost was in real terms. Obviously the $ in 3 and 4 are worth more than the $ in 2. This will bring the amounts closer together.

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CPI adjustments push up the cumulative loan each year, so apart from the compounding element the amount repaid should be the same as the amount borrowed in the dollars of the original year.

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Yes, but isn’t your ‘total cost’ in nominal dollars? Presumably this goes up as the repayment time extends?

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Yes, in nominal dollars. In a better model more account would be taken of price movements, especially on the wage side – I have used lumpy 5 year age bracket data with 2006 data inflated to 2010 levels, when in reality it should be annual data which assumes further annual inflation in the repayment period, which heads out to 2021.

The purpose of this exercise wasn’t to get precise figures but to start to get my head around the comparative financial impact for students and for goverment of the different ‘bonus’/penalty options.

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