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.
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.