Why you shouldn't fear HECS
The 2023 HECS indexation rate has just been announced (at 7.1%) which is unsurprisingly causing significant angst among the 3 million Australians with a HECS debt. But it's important to understand what this really means for you and what, if anything, you can, or should do about it.
HECS (properly called HECS-HELP) is one of the most misunderstood Government programs in Australia. Certainly it's one that creates the most fear and mistrust among young Australians and one that generates a lot of questions here at Sherpa HQ.
In part, I suspect, this is a result of the Government's portrayal of it as a loan rather than just an income tax surcharge on graduates. Understanding this distinction won’t make it cost you any less but it will hopefully make you feel better and remove some of the anxiety about having to carry around this debt burden.
History of HECS
The benefits of attending university accrue partly to the student through higher lifetime income and partly to the nation as a whole.
In truth a significant amount accrues to the shareholders in breweries, but that is a story for another day - or maybe that was just me and my classmates ;).
Many countries have grappled with the right way to divvy up the cost between the various beneficiaries.
Until the 1970’s universities charged their students fees and some students gained scholarships or cadetships which covered some or all of their fees. This, in effect, meant that the student or their parents picked up the tab, unless the student won a scholarship.
In 1974, the Whitlam Government abolished fees and heralded a golden period of essentially free university education. This ended in 1989 when the Hawke Government introduced HECS. Under this system each student had to pay a flat student contribution of $1800 per year. This amount could be deferred and collected through the tax system once the student’s income exceeded a threshold or it could be paid up front.
The Howard Government finessed this by replacing the flat fee with a three tier fee, where the courses that would generate the most income for a successful student (Law, medicine, commerce, economics) would incur a higher fee than those that led to lower paying careers (humanities, social studies, visual arts). This is the system that remains today.
What does this mean in practice?
Most University undergraduate students qualify for a Commonwealth supported place which means they only have to pay the student contribution (which for the Bachelor of Commerce is $15 142 for 2023). Allowing for a bit of inflation over the three year period the total student contribution for the course would come to around $50 000.
A student may either pay this at the time (usually March and August of each year) or choose to pay it through the income tax system later. Paying upfront no longer attracts a discount.
No payments are required until the graduate’s income exceeds a threshold ($48 362 for the 2022/23 tax year. The median starting salary for a (male) graduate in 2022 was $69 400 ($67,400 for females) according to the QILT Graduate Outcomes Survey
Each year the HECS balance is indexed to inflation on June 1. Payments made through the PAYG withholding system are credited to your HECS acocunt only when you lodge your tax return. Additional voluntary payments can be made at any time and are credited straight away.
Here's why HECS not like a loan
HECS is not like any other loan – so don’t panic too much.
To some extent it is like a loan. The Government keeps calling it a Debt. But most importantly it reduces the amount of your income available for living, saving and investing. To this extent it feels like a loan.
But it has a number of features of HECS that mean it’s not like any other loan and is more like an income tax surcharge.
1. You only ever have to pay it off if your income exceeds the threshold
Payments are only required when your income exceeds the threshold.
This means that if you earn the median graduate salary of $69 400 you would normally pay $14 410 in tax, but if you have an outstanding HECS balance you must pay an additional $2 429. This will be collected with your normal tax.
The amount paid is credited against your outstanding balance.
2. If you die it dies with you
Because payments are required only when your income exceeds the threshold, the balance is in effect cancelled when you die. In the year you die, you will still make the payment based on your income (including anything earned by your estate after your death). The unpaid amount is not deducted from your assets before they pass to your heirs.
Some of the indexation rate should be attributed to this form of life insurance. How much would you need to pay to buy a life insurance policy with a benefit equal to your outstanding HECS balance?
3. The payments you make depend on your income not on the outstanding balance
The amount you pay each year is dependent only on your income not on the outstanding balance. The more you earn the more you pay. The only exception to this is in the last year when your balance falls to zero. If the amount calculated by applying the relevant percentage to your income exceeds the balance you only have to amount to make the balance zero.
4. There is no interest (but it still rises)
Techincally, no interest is charged on your HECS balance. However, it is adjusted each year on June 1 to preserve its value in real (inflation adjusted) terms. This means it is increased by the rate of inflation.
The increase is based on the Consumer Price Index, more commonly known as inflation or CPI. Technically it's the All Groups Consumer Price Index number (being the weighted average of the 8 capital cities).
The Reserve Bank has been targeting inflation since the early 1990's and has been remarkably consistent in keeping it in its desired range of 2-3% on average over the economic cycle. As a result, the average annual HECS increase since 1990 has been 2.76%.
This is obviously much less than the rate charged on commercial loans such as mortgages or credit cards.
The average home loan rate since 1990 has been 6.74%, only in 1990 and 2023 has the HECS indexation rate exceeded this.
Today we are experiencing an unusual blip in inflation, largely due to global factors, with the indexation factor for 2023 hitting 7.1%, its highest rate since 1990.
It is easy to get spooked by the return of inflation, which will be unfamiliar to most who have a HECS debt. But it would be rash to make a decision based on what is likely to be a one year blip.
For those in a position to repay their debt in full prior to the 2023 indexation date, and who would otherwise have repaid it through the compulsory repayment system in the 2024 tax year, there is an opportunity to save money and reduce the cashflow impact. For all others, the question is much more nuanced.
5. It doesn’t count the same as a loan when you go to borrow money
When a bank assesses the credit worthiness of a potential borrower, they are concerned about how much income you have, how much you owe other people and what other commitments you have each month which might reduce the amount of your income that could be used to service the loan.
The amount of any potential loan will be reduced by the balance outstanding on other loans. The amount of the monthly payment on those loans reduces the available cash to service the loan you are applying for. Usually this cashflow impact is calculated at an interest rate well above th erate you are actually paying.
With HECS, the bank is primarily concerned about the impact of the HECS payment on your net income, and they apply the actual amount of the compulsory repayment.
Recently banks have started to include the balance on your HECS debt in calculating a measure known as the Debt to Income Ratio (DTI). This is a measure of how many years income is represented by the total amount of your debts (DTI = Total debt outstanding divided by gross before tax income). Some banks have a hard limit on the multiple, others apply more stringent rules where the DTI is above 6x. Usually this will only be an issue for people with investment property income (and debt) as well as their salary.
6. You don’t need to get your parents to guarantee it
Your HECS balance is completely unsecured. That is the Government doesn’t require a mortgage nor do they require you to have your parents guarantee the balance. A bank lending in the same circumstances would look for additional security like a parental guarantee.
7. It survives bankruptcy
Bankruptcy is one of the options available if someone is unable to pay their debts and it all gets too much. This is not an option to be taken lightly. When someone is declared bankrupt, all of their assets (other than tools, a cheap car and some household effects) are taken to pay the debts and the balance is wiped clean.
Where the bankrupt earns more than about $60 515 annually, they have to give the balance to their creditors for a period. It’s a pretty drastic step and can adversely affect the rest of your life.
Family support, court fines, Centrelink debts and HECS must still be paid.
However, being bankrupt doesn't prevent you taking out a new HECS debt - it might even be a good time to consider going to Uni!
When should you take advantage of HECS and when it makes sense to pay it off.
One of the most common questions I get at Life Sherpa® is “Should I pay off my HECS?”. In almost all cases the answer is NO.
There are very few circumstances where it makes sense to make additional payments on your HECS debt unless you can pay off the full balance. Any lesser payment will not impact the payments you have to make in future years (until the last year).
If you are a home owner, you are likely to get a better financial outcome by using the money to make additional repayments.
If you are planning on buying a home, the money is likely to be more usefully applied to making a larger down payment which will reduce or eliminate the cost of Lenders Mortgage Insurance.
If you are earning more than $106 000 and have a larger deposit, paying off your HECS in full could give you sufficient extra after tax income to qualify for a larger loan. At that income level, the additional borrowing available because of the removal of your HECS repayment will offset the impact of the lower deposit (on the loian required and LMI cost) allowing you to buy a more expensive property. A good mortgage broker who works with first home buyers can help do the numbers for your circumstances.
A slightly more complex variant on this is should I pay my Student contribution or should I defer it and use HECS?
Should I use HECS?
An undergraduate student is faced with a decision every semester as to whether they should pay the Student Contribution (up to $15 142 per year) in full or in part or should they defer it using HECS.
The answer is a little bit more "it depends" but in many cases a student and their family will be better off over their lifetime by deferring.
The “depends” is where the money is coming from and the alternate uses for that money. You might not want your parents to see this!
Parents don’t sacrifice your retirement to avoid HECS
As parents we all want to set our kids up with a good start in life. That’s why we’re keen for them to go to university after all, I guess. But paying the $50 000 or so to completely avoid HECS, not to mention the food, books, travel and beer money it takes to be a real student, can make a big hole in your retirement savings.
The same money applied to super contributions could increase your retirement nest egg by over $100 000. Alternatively, applied to reduce your home loan could go a long way towards your goal of having the house paid off by retirement.
Unless you have a fully funded retirement fund and a debt free home or are a long way off retirement, you are likely to find that there are big benefits in taking the HECS option.
Remember you can borrow for your kid’s uni education but it is pretty difficult to borrow for retirement.
If you are keen to pay, there may be better things to do with the money
Even if you are keen to pay the Student Contribution, you are likely to better off setting the money aside and depositing it to your mortgage offset account or contributing it to super during the uni years and making an additional voluntary HECS repayment later.
HECS strategies for Parents.
If you can do anything that will earn or save you 5% before tax (on average) it is likely to be a better solution.
Use the Money to Set your kids up for life
An alternative to paying the Student Contribution is to invest the money for your kids. By doing this your student could have a deposit for a house of $63 000 on graduation.
In brief, if you have any debts or do not have a fully funded retirement fund or can think of any other way to earn 5% (pre tax) with your money, you should not pay the Student Contribution. I say 5% because for most people this will result in an after tax return greater than the average HECS indexation over the past 30 years.
A Student’s View
If you are borrowing any of the money you need to get through uni, then you should take advantage of the very cheap money and easy terms available from the Government through the HECS scheme. That is you should choose to defer your Student Contribution.
If you are working (part time or full time) to fund your education, you may be able to claim your Student Contribution as a tax deduction. This would apply if the course was directly related to your current job – not the one you wish you had! And if it is payable under FEE-HELP or VET FEE-HELP (but not HECS-HELP). Here is the ATO position.
This is one of the few circumstances where it may be better to pay the Student Contribution up front - But only if you have no other debts (such as credit cards).
If you are working and not able to claim a tax deduction, think about how many additional hours you would have to work to pay the Student Contribution.
At the minimum wage for an 18 year old of $14.97/hour, you would have to work 19.5 hours a week just to pay the Student Contribution.
Think about the impact this might have on your ability to study and enjoy Uni.