Am I better off paying HECS upfront?

[costargh]

Am I better off paying HECS upfront?

From Money Magazine

Paul Clitheroe weighs up the pros and cons of paying HECS upfront as thousands of students prepare for university.

Many students will be wondering whether or not they should pay their HECS (Higher Education Contribution Scheme) bill upfront. How much you pay varies according to your degree and place of study, given the universities now have some flexibility — within government-imposed limits — over the amount of HECS they can charge.

Areas of study are classified into one of four bands. The more expensive Band 3 degrees, such as medicine and law, can cost up to $8170 annually, while at the bottom end of the scale, "national priority" subjects such as nursing and education can cost up to $3920 each year.

You can pay HECS upfront in full or part ($500 plus) and get a discount of 20 percent or take on what's called a HELP debt. You start to repay the debt when you earn over $36,185 a year (2005-06 figure, indexed annually to AWE).

A 20-percent discount for paying upfront is compelling. But it's worth weighing up against the alternatives, because HELP debts are interest-free, though the balance of the debt is adjusted annually for changes in inflation.

Option one — pay upfront
It's nice to get it off your back, but consider all the options. First of all, let me say that paying upfront is not the best option if you have to borrow the money to meet your HELP debt. It doesn't make sense to pay commercial interest rates to repay an interest-free debt — more so because HECS is not tax-deductible. So you need to have the money on hand, which would be unlikely for many students.

If you pay your compulsory student contribution upfront, whether in full or part, you get a discount of 20 percent. Paying upfront means that you pay your discounted contribution early in each semester (by the "census date" set by the university, which is no earlier than 20 percent of the way through the semester).

Let's say, for instance, that Mike is enrolled in a three-year science degree, a Band 2 area of study for which the maximum contribution is $6979 for each year of study.

But since 2005 each university has been able to set its own HECS levy up to the maximum, so for the sake of simplicity we'll assume Mike's university decides on an annual HECS charge of $6000 for each of the three years of his degree (though it seems a lot of universities, especially the more prestigious ones, are charging the maximum). This $6000 will be indexed by inflation (under the new laws relating to HECS introduced at the start of 2005, unis can increase fees in step with inflation). So, assuming inflation of 2.4 percent per annum (CPI for 2005, www.ato.gov.au), year two will cost $6144 and year three, $6291.

If he pays his annual HECS fee upfront each year, it will cost him only $14,748 for the three years, paying as he goes. This is a saving of $3775 over the HECS debt of $18,874, once both sets of fees have been adjusted for inflation. Mary, undertaking a more expensive five-year course, with a first-year cost of $8000, will pay a total of $33,574 over the five years, representing a saving of $8796 over the HECS cost, inflation adjusted.

That's not a bad result, with the additional attraction that neither Mike nor Mary will have a debt when they start work after graduating.

But there are a number of other ways cash-strapped students could use the money to earn a better return. And as unlikely a choice as it may seem for students, one potentially attractive option may be super.

Now I wouldn't normally suggest super as a priority for tertiary students, but assuming Mike works part-time while studying — earning less than $28,000 a year, he could be eligible for the government's co-contributions scheme.

If Mike made a voluntary super contribution of $1000 in each of his three years at university, rather than paying all his HECS, he would be eligible for an annual government co-contribution worth $1500. That's an instant return of 150 percent each year, which makes an annual saving of 20 percent look paltry. And any upfront contribution of $500-plus to his HECS will still earn the 20-percent discount.

If they don't pay the HECS bill upfront, after graduation students can elect to make extra voluntary partial repayments of their HELP debt at any time. Payments of $500 or more are rewarded with a 10 percent "bonus". If Mike makes a voluntary payment of $600, his HELP debt will be reduced by $660 (being $600 plus a 10 percent bonus of $60). Try to make voluntary payments before June 1 each year when the debt is CPI adjusted.

Option two — defer HECS
It's an interest-free debt and other outlays might be a priority.

It's estimated that around 80 percent of students choose to defer HECS and take on a HELP debt. When your income reaches $36,185, HELP is repaid through the tax system, starting at four percent of your annual income and rising to eight percent of annual income when you earn $67,200 or more. As the median starting salary for new graduates was $40,000 in 2005 (www.graduatecareers.com.au, GradStats), most graduates are likely to begin their repayments almost as soon as they enter the workforce.

As HELP is an interest-free debt, it doesn't have the usual bugbear of compounding interest. At worst the debt increases in line with inflation, so the real value remains unchanged.

Nonetheless, many students choose to defer their debt out of financial necessity — they simply don't have a spare few thousand dollars at the start of each semester. And don't forget you can make a voluntary extra payment at any time after you graduate to reduce your debt and payments of $500 or more attract a 10-percent bonus. Note, however, that from 2005 these payments are no longer refundable.

Others defer because, quite sensibly, they would rather use any available funds to pay for education expenses such as laptops, tutoring or textbooks or to travel during and after their studies. These are all perfectly good options because by furthering their own education, tertiary students have already made an outstanding investment in themselves.

Conclusion — it all depends on your cash flow.

I'm the first to admit my heavy bias in favour of young people grabbing whatever education they can, for the simple reason it leads to better opportunities — and it's fun. My own experience at university provided a sensational start to my adult life and whatever money was spent on my studies has been returned many times over, making the outlay for my education the single best investment I've ever made.

That's why I reckon the argument about whether to defer HECS is a bit marginal. If you can afford it and have the cash to make the upfront payments, then you get the benefit of a generous discount and the peace of mind of knowing you won't graduate with a degree in one hand and a $10,000 debt in the other.

But if you don't have the money or want to spend it on enhancing your educational experience (including travel and parties), don't stress about building up a HELP debt. Sure, it's a major cost for new graduates, but it's one that should see you reap the returns of a better-paid, more rewarding career throughout your life.

http://money.ninemsn.com.au/article.aspx?id=100209

[Eriny]

I paid HECS upfront last semester but I don't think I will next semester. In my situation, it makes much more sense to defer, even though you get a nice little discount for upfront payments.

[brendan]

http://www.smh.com.au/articles/2004/03/12/1078594564502.html
Time takes its toll on value of HECS discount

By Ross Gittins
March 13, 2004

This is the time of year when a lot of uni students and their parents demonstrate their ignorance of a key concept in economics and business - the "time value of money".

Actually, when it's used in business and finance to evaluate investment proposals - as it is every day - it's more commonly referred to as "discounted cash flow" analysis, which yields a bottom line called the NPV - net present value. If you've ever come across these terms and been puzzled by them, keep reading.

But why would uni students and their parents benefit from knowing about such arcane stuff? Because it's the key to jumping the right way when you decide whether to pay your HECS (higher education contribution scheme) fees in advance - and get the 25 per cent upfront discount - or let them ride and have the taxman take the repayments out of your pay after you graduate and get a job.

A lot of people take one look at that whopping 25 per cent discount and conclude it's a no-brainer. If you had the money, you'd be a mug not to take advantage of the discount.

But get this: it's not at all obvious that the 25 per cent discount is a good deal, and for most students it won't be. They'll end up richer if they let their HECS debt pile up.

How could that possibly be? Because of the "time value of money".

Economists believe that, when it comes to paying or receiving money, it's not just how much that matters, but also when it happens. The basic proposition is that a dollar today is worth more than a dollar tomorrow (or in a year's time).

Why? Not just because of inflation. The proposition would still be true if there were no inflation. No, the real reason is because humans are impatient animals. If we had the dollar today, we could spend it today, which would be better than having to wait. (Or we could put the dollar in the bank and earn interest.)

If I could quantify your degree of impatience, I could express it as your personal "discount rate". And if, for example, your discount rate was 6 per cent a year, this would mean that the promise of receiving a dollar in a year's time would be worth 94.3c to you today.

That 94.3c is said to be the "present value" of a dollar in a year's time, at a discount rate of 6 per cent.

Note that this calculation works both ways. If you're going to be paid a dollar in a year's time, its value to you today is only 94.3c.

But if you have to pay the dollar in a year's time, its cost to you today is only 94.3c. If today you were to put that 94.3c into a bank account paying 6 per cent interest, in a year's time you'd have the dollar needed to pay your debt. (So discounting is compound interest in reverse.)

Most business investments take the form of having to shell out a lot of money now in the hope of getting back a small stream of money over many years into the future. Those distant-future dollars aren't worth nearly as much as the ones you'll have to cough up right now.

So, to put all the dollars in the sum on a comparable basis, the distant dollars need to be discounted before they're set against the present dollars to give the investment project's "net present value".

Now, if you're a financial type who is highly conscious of the need to discount future events, you view the HECS arrangement as remarkably generous. Students owe the Government money, but it allows them to delay repaying until they can afford to.

Normally, a bank would charge you interest on such a deal, but all the Government does is adjust the amount of your HECS debt in line with inflation. In other words, it charges you a real interest rate of zero.

What? Someone's offering to lend you money at a zero real interest rate? A "rational" person would need a lot of persuading to pay off such a loan before they were obliged to.

The only thing that could induce them to do so would be a really huge discount for repaying upfront. So the key question is: is 25 per cent big enough to outweigh the attraction of a loan with no real interest rate?

Let's say the amount of HECS involved this year is $4000. With a 25 per cent discount you'd make an upfront payment of $3000. You compare that figure with the present value of all the repayments you'd have to make over the years after you graduate.

If that present value is greater than $3000, make the upfront payment - and the difference (not the $1000 discount) is how much you save. But if the present value is less than $3000, you'd be a mug to pay upfront (assuming you've got the money). At a discount of only 25 per cent, it's just not worth your while.

That's the theory of it. In practice, however, working out the present value of the stream of future debt repayments is a job for an expert with a computer program. And you have to guess how much income you'll be earning (because that's how the size of your repayments is determined).

Don't forget, however, that the HECS rules are about to change. Students who've started their courses before next year won't be affected by the 25 per cent increase in fees (a fact the vociferous opponents of the changes haven't bothered to stress).

But from July this year, the income threshold at which you have to start making repayments jumps from $25,348 a year to $35,000 (and goes to $36,184 from July next year). And from January next year, the upfront discount drops from 25 per cent to 20 per cent.

It's obvious that this cut in the upfront discount makes paying upfront less attractive. But, for many students, so too does the jump in the repayment threshold.

Why? Because it tends to push repayments further off into the future, meaning they're more heavily discounted to reduce them to their present value. And the lower the present value, the less the likelihood that paying upfront will yield genuine savings.

From what I can gather, it's only those students whose earnings in their first 10 or 15 years as a graduate are significantly above the average for graduates who are likely to be better off paying upfront.

Ross Gittins is the Herald's Economics Editor.