Student loan advice

[vass]

The only debt I carry is my HECS/HELP debt (Australian student loans.) Mine is much larger than the average of $15,000, because I was at uni for three years longer than the norm for my course, and had to repeat a lot of classes due to disability issues which still affect me.

Australian student loans are government-owned, and are adjusted according to the consumer price index, but otherwise do not attract interest. No repayments are needed until the debtor reaches the repayment threshold, currently $44,912. I make nothing like $44K. I really don't make a lot of money at all.

If you make a voluntary repayment of $500 or more, you get a bonus of 10% on it, i.e for $500 the government wipes out $550 of your debt.

I don't like being in debt, even debt as benign as HECS/HELP. It hurts my pride.

If I saved as much extra as I could manage per month (on top of my normal savings) in a 5% savings account, then repaid that year's savings, including interest, and kept doing that every year until the debt was gone, it would take me 20 years (not accounting for inflation, because I have no idea how to do that, and I can't find a website that will give me a guideline. Any suggestions? At any rate, I hope and trust that it's less than 5% p.a.)

If I saved the same amount per month in a 5% savings account, then didn't repay it until I reached the target amount (again, without accounting for inflation) and then repaid it in full, it would take me 15 years.

Obviously, I'm hoping that I'll earn a higher annual income over the next 15-20 years, and be able to reach my goals sooner and form some new ones. But I want to start now.

The other thing to consider is that if I reach the repayment threshold, it will take me 15 years to repay my debt if I pay the minimum every year. And I don't know when (if ever) I'll reach that minimum threshold.

I guess what I'm looking for is support to do the smart thing and put the money in savings so I can repay it faster, not repay it five years slower just because it's psychologically more satisfying to see the numbers go down instead of seeing them actually go up through indexing.

Comments

[willful_zephyr]

My wife taught me about the Time Value of Money. With inflation, $40k in 20 years is less money than $40k now. So, if you owe money now, you will owe less in 20 years even if you make no payments on it - assuming net inflation over that time.

So, if you have a loan that is accruing interest at a rate less than inflation, you want to take as long as you possibly can to pay it off. This holds true if you have investment options that make a higher rate of return than the interest on the loan - the money will be more productive in the investment than in paying down the loan.

[martyna]

I agree. That what I have been taught -at uni-, too.
(Though, emotionally, I'd like to pay off the loan as soon as possible, too.)

[willful_zephyr]

I try not to think too hard on our low-interest debts (student loans and mortgage), just make the payment. Some day they'll send me a note that we're done.

[kuangning]

You know, what you're proposing to do if you start repaying before you hit the repayment threshold is, essentially, to reject your government's very sensible system which triggers off your income level, and harness yourself into something closer to the US system which triggers repayments regardless of income after a certain amount of time. I don't see why you'd seriously consider that; your governement's system is quite fair and designed to not saddle you with crippling debt repayment before you can afford to pay it.

Use your current money to support/establish yourself and save for emergencies, as you are intended to do. When you actually reach the debt threshold, you'll be in a much better position to make voluntary payments to clear your debt faster, and you can make that a priority then, since you will hopefully already have a good stash for emergencies and a bit of a nest egg as well.

[vass]

I don't know if you intended it to, but that came across as quite judgemental.

The fact that I would prefer not to be in debt does not mean I'm rejecting my government or trying to be like America, for Pete's sake.

[kuangning]

Note how I specifically said "your government's system" and not "your government." I said what you'd wind up in if you start repaying early is akin to the US system, because the effect is. I did not say you were trying to ape the US. You would, however, be strapping yourself into debt repayments you cannot currently afford, which is a common effect of the US system, hence why I used the comparison, and doing so unnecessarily because your system is set up to prevent that from happening to you. Work with the system you have; it will leave you paying off your debt faster and with less hardship than if you start struggling to make repayments before you can afford them.

[foxfirefey]

If it helps psychologically, maybe make a spreadsheet that shows how your debt is going "down" from your savings? That is, instead of paying the student debt, put the money into a savings account.

When you put the money into your savings account, record what your student debt currently is (since it changes from indexing) and would be if you used *all* the money in the savings account to make a payment (with that 10% bonus!) for that date.

That way, you'll be able to see your student debt go down, but still have the savings--which could be useful if you ended up needing access to that money from some emergency, too.

[all_adream]

I have to admit to not understanding this, actually: when I pay $1,100.00 a month for my mortage, which is the basic amount plus an extra hundred or two, it makes the overall total go down steadily in years and in total interest paid, so that it will take me less time and less money overall. I'm somehow not understanding why your situation doesn't do that too--what am I missing, do you think?

[jamethiel]

The HECS/HELP debt from the government doesn't accrue interest. It's indexed at the end of each financial year, so it does go up after time, but compared to keeping money in a savings account where the interest is compounded monthly, AND the interest is usually at a higher rate than the indexing applied by the government, the savings account soon outstrips the yearly indexing in terms of money added.

[white_aster]

I think that it's the power of compound interest? If OP saves, then takes everything out and shoves it at the loan each year, it would take 20 years, because each year they'd be cleaning out their nest egg, rather than letting it accrue interest. Leaving everything in the account and paying up at the end would take 15 years because the entire nest egg is making interest the whole time....

...Is that what you meant? ^_^;;

[all_adream]

I guess that is what I meant. I thought, though, that if I paid $1,000.00 a year (plus tiny interest from keeping it in savings for that year), it would take the $1,000.00 plus the five or ten bucks off the principal/loan total, and so then the amount owing on the total would be reduced by that amount plus whatever else would have accrued during that time, which would then compound as well. In other words, I mean (if I'm making it confused-sounding!) that the next year, instead of paying the entire (made-up for convenience) figure of $10,000.00 plus whatever compound interest on the loan would have accrued in that year, I would have paid the thousandish off the top, and then the next year I would only owe $9,000.00 plus the compound interest. I must have missed something about interest rates in the original, because the only way I can see it making the best sense if if the interest rate on the savings considerably outstrips the interest rate on the loan. You know? There must be something in the original that I need to go back and read again. Thanks for trying, you guys! I'll reply to myself and you when I see whatever point I either missed or still believe to be true! ahahaha!

[all_adream]

I see the part about the income-dependent and not accruing interest and all. I think that looking at an amortisation chart would be helpful, wouldn't it? Then you'll see most clearly, like some people above suggested. I think there are tons of free ones all over the net, so let me find you one and post it, maybe as an independent entry so we can always find it.

[jamethiel]

The thing is, this debt only gets indexed once a year. So if you like, the compound period is a year. So to use your example, with a debt of $10,000 and an indexation rate of 4%, if no payments are made, after the first year, the debt is $10400. The next year, that $10,400 gets indexed. If the indexation rate is still 4%, the debt is then at $10,816.00

The highest interest rate savings account out there at the moment (in Australia) is at 6.51%. The compound period is daily and the interest is paid monthly. So if the person in question is paying $100 a fortnight into a savings account, at the end of one month, they would have $0.32 on top of what they've saved. 2 months would be $1.81 total interest over the period, three months would be $4.50. It's compounded on top of what's paid before, and the person keeps adding to it.

At the end of one year, they'd have $83.13 in extra interest, and at the end of two, they'd have $346.72. This is still well below the yearly indexation just because the debt involved is $10000. By the third and fourth years, the total interest on the savings account is still less than the total indexation on the debt, but on the fifth year? Something interesting happens.

The total debt is $12166.53. The total amount in the savings account, is $15345.81. So in that five years, even with saving $200 a month, the total amount added to the debt is $2166.53 and the total amount of interest earned by the savings account is $2345.81. So because of 1) higher interest rates on the savings account and 2)compounding daily and paying monthly rather than once a year and 3) continually paying money in, the interest from savings outstrips the amount accrued by indexation.

Which is why it does make more financial sense to put it into a savings account. However, paying off debts is almost never a bad thing and finances is as much about emotional sense as anything else.

[all_adream]

Good, thank you: that is succinct, and the only question I would have would have to do with the possible benefits of the extra ten percent on payments over 500, and if doing those in a staggered way would eventually pay off, since 110% of a certain figure being paid off at once could indeed reduce the rest enough to make it worthwhile to do at intervals.

[jamethiel]

Think about it in terms of interest saved = interest gained.
With our example above, it takes 10 weeks (2.5 months) to save $500. The amount of interest you will have earned in that time from the savings account is $3.01. So your payment of $503 becomes a payment of $553.00 (The ATO doesn't count the cents in a HECS debt).

You do this five times a year for the first year. That is... $265 interest. Every fifth year, you get $318, because it takes that long to make an extra payment.

In the first year, you make payments of $2765. Your $10 000 debt becomes $7235 and then $7372 after indexation (I'm using last year's indexation of 1.9%). That's $137.46 of interest lost, so your interest overall for the first year is $127.54.
With indexation and extra interest from the 10% and the interest from savings, it takes you three years and 9 months to repay your debt. Over that time, the interest (Taking into account all of the bonuses from the 10%, all of the interest for the short time you have your money in the savings account) is $693.24

(I've done those calculations if you want to see them)

After three years if you leave the debt alone and assuming indexation is 1.9%, the debt is at $10580. The amount that you have to pay to pay out the debt is $9620. You reach that in your savings account after 40 months, which is 3 years and 4 months. Five months sooner than you repay your debt with the gradual repayment system. The interest earned from your savings account is $1000, take away the $580 of interest lost from indexation and you have $419 of interest. Then you apply the 10% bonus, and all of a sudden the money you have earned through interest becomes $1381.

So. You get to pay your debt off five months sooner and you earn around twice the amount of interest.

[all_adream]

I see how these options get down to whether the original poster has strongest feelings about sooner or about less or about other factors involved, plus the wildcard aspect of maybe winning the pools or getting more or less income somehow unexpectedly. Thanks for all the calculator action!

[white_aster]

I am like you: I wanted to pay off my debts as soon as possible, though I didn't really need to (my loans were accruing interest, but I was still in school, so didn't trigger repayment). Not having debt is always better than having debt, even benign debt.

First thought: it is best to do what will make you sleep better at night. If it bugs you to have that debt on you, then do whatever it takes to make yourself feel better. Period.

Second thought: man, Australia's repayment laws make so much more sense than the US's. ;_; The other commenter does have a point, that the laws are trying to not make you repay until you're in a better situation to repay without hardship. But hey, if you're not sure if you're going to BE in a better place to repay 5 or 10 years from now, and if you can pay now and want to, good on you. Just make sure that you've got an emergency fund stashed away, too.

All the numbers being equal, my thought was like firefoxfey's up there: don't look at your student loan balance: look at what you've saved. Set up a spreadsheet, post-it note, whatever to start with your loan balance, then deduct off it every time you make a deposit to your savings.