The longer-term effects of upfront discount rates

Rajat asks about deferral trends over time. The figure below is the percent of total student liabilities deferred 1989-2009.


Source: Higher Education Report 2009.

As you can see, the trend is consistent with discount rate having an effect. When it increased in 1993 from 15% to 25%, more people paid up-front and the deferral rate dropped. When the discount decreased from 25% to 20% in 2005, the deferral rate increased, ie fewer people considered it worth paying upfront.

The data is also consistent with the effect building over time. Perhaps one mechanism is that defer/pay habits are established in first year and continued, perhaps without awareness that discount rates have changed. But as new students who made a different calculation displace older cohorts, the % deferring changes.

On the other hand, we have some fluctuations from the mid-1990s to the early 2000s without any change in the up-front discount, so possibly other factors also influence the decision to defer or not. One quirk I cannot adjust for in the data is that New Zealanders and permanent residents are entitled to Commonwealth-supported place but not a HELP loan. They have to pay up-front without a discount.

With this caveat, I calculate that if the same rates of deferral in 2004 had applied in 2008, lending would have been $38 million lower (ie, lending increased by $38 million). However if the up-front discount rate had remained at 25%, its total cost would have been $45 million higher. So even making very pessimistic assumptions about repayment rates on the $38 million, the Commonwealth is ahead financially. But it suggests that the effects and savings are not that large in the context of annual lending of around $2.2 billion in 2009.

5 thoughts on “The longer-term effects of upfront discount rates

  1. Thanks Andrew. I think you may be right about the effect compounding over time due to the cohort effect you mentioned. It might feel weird to suddenly start paying up-front after having deferred for the first couple of years of a degree or vice versa. It’s hard to know what to make of the curve from 1997 to 2004. One thing I find odd is that the line goes down in key ‘recession’ years such as 1991 and 2009, when rationally one would expect more people to defer in the expectation of weaker economic times (and job prospects and CPI inflation) ahead.

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  2. It’s just a matter of framing the problem. Don’t think of it as the government cutting the discount for paying upfront. Think of it as the government cutting the penalty for paying later. That’s much more palatable.

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  3. SofR – The people who designed the system did frame it well as a discount rather than a penalty – which minimises the psychological pain for the vast majority of people who defer. The trick just doesn’t work so well when the discount is reduced.

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  4. Andrew, Thanks for this. I presume some of the upward trends (eg, from 1997 and 2004/5) also relate to HECS price increases – particularly the 25% jump in latter years, remembering that people can defer part of their liability.

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  5. Russell – A good point. It’s also worth noting that the total value of upfront payments has never declined, but it has fluctuated relative to the total original liability.

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