Chapter 2 - Other personal debt and how to manage it
As we saw in the previous chapter, home loans are the largest single type of personal debt. But there are other types. We discuss the two main types here: personal loans and student loans.
One type of personal debt is a simple personal loan. These are typically loans for smaller amounts and are typically used for private purposes like buying a car or taking a holiday. (That said, they can be used to finance business or investment activities. But we will assume in this chapter that the personal loan has been used for non-income producing purposes).
The loans are typically unsecured and attract interest rates that are much higher than you would pay on a secured loan such as a home loan.
In many ways, personal loans should be managed as if they were home loans. They should be repaid as a priority if you also have cheaper debt such as a home loan, and you could think about using the super system to repay personal loans if you are approaching or have reached preservation age.
If you have any spare cash, this should usually be used to repay a personal loan. Similarly, if you have the capacity to draw further on a home loan, then you should do this to pay out the personal loan. This is replacing one type of private debt with another, but because the home loan has a lower rate of interest you will be better off.
The Australian Securities and Investments Commission (ASIC) have substantial information on their website about personal loans. You can read the material here. They even have a personal loan calculator that you can use to calculate your borrowing capacity and your repayment capacity. You can use the calculator by clicking on the image below:
Student loans are loan monies extended to tertiary students to help pay the costs of their degree or diploma. In Australia there are two main forms of student loans. These are HECS-HELP, which are typically available to students studying at undergraduate level, and FEE-HELP, which are available to people studying in a fee-paying course.
(Photo courtesy of Jason Tong)
HECS-HELP loans are available to eligible students who hold a ‘Commonwealth Supported Place’ in a higher education facility such as a University. Australian citizens and holders of particular visas (such as permanent humanitarian visas) are eligible for HECS-HELP assistance.
The HECS-HELP system is a generous one and most University students make use of it. This is the case even for those students who could afford to pay their tuition fees ‘upfront.’ Accordingly, most graduates graduate with at least some level of HECS-HELP debt.
HECS-HELP debt is quite simple to manage. Repayments are made via the taxation system, with the ATO demanding repayments when your income rises above the compulsory repayment threshold. This threshold is currently just over $54,000 a year. No repayments are calculated on the first $54,000 that a person earns. Amounts above this threshold are taxed at an additional 4%, with the tax rate increasing by 0.5% for every $6,000 or so of increased income. A person earning taxable income of $70,000, for example, will be paying 5.5% additional tax on the last dollar earned.
You have no choice about repaying this debt. If your income exceeds the threshold, the ATO demand a suitable amount be repaid.
Strategies for managing HECS-HELP debt
While HECS-HELP is a debt, the typical ‘strategy’ is that people should not pay it off any sooner than they have to. Historically, people have received a bonus for amounts repaid voluntarily. The bonus is currently 5% on amounts of $500 or more. So, if a person repays $1,000 voluntarily, their account is reduced by $1,050. However, the capacity to do this ended at the end of 2016, after which there is now no incentive for early repayment.
Even with the incentive, it was rarely in your best interests to repay HECS-HELP debt any faster than the ATO request. This is because the debt is effectively interest-free, with only the inflation rate being applied to outstanding amounts. This means there will almost always be a better ‘return on investment’ to be had elsewhere. For example, if you have any form of interest-bearing debt, such as a credit card or home loan, you will achieve greater savings in future interest by retiring these debts first.
If you do not have any other forms of debt you would still be better off directing money towards the accumulation of assets, through such avenues as superannuation.
What’s more, unlike virtually all other forms of debt, if you die with a HECS-HELP debt your estate is only liable to make the repayment that would have been payable in the year of death. All other HECS-HELP debt is cancelled. Dying with a HECS-HELP debt is the same as dying with no debt. (From time to time there is talk of changing this, but as yet the situation remains that HECS-HELP debts are cancelled upon death).
So, it makes sense to wait until you have to repay this debt, and to not repay it any sooner than that.
FEE-HELP loans are those made to Australian citizens and some other Australian residents who are completing an eligible course of study. The difference between FEE-HELP and HECS-HELP is largely to do with whether the University place occupied by the student is a fee-paying one. If so, FEE-HELP is likely to apply.
The FEE-HELP facility is generous, but not as generous as HECS-HELP. Unlike HECS-HELP, which is uncapped, FEE-HELP is capped at just under $100,000 (it is about 25% higher for medicine, dentistry and veterinary science studies).
FEE-HELP debt is repaid at the same rate and by the same method as HECS-HELP: the ATO levies a repayment amount on all income above the compulsory repfiayment threshold of just over $54,000.
FEE-HELP and HECS-HELP do have one difference: where FEE-HELP is being levied on a student in an undergraduate course, other than one being provided through Open Universities Australia, there is an additional fee to the value of 25% payable by that student if they use FEE-HELP. Accordingly, these students are generally better off paying their fees upfront if possible.
The loan fee is applied ‘as you go.’ That is, the loan fee is applied at the same time as the FEE-HELP debt is created. From that point on the loan fee is added to the overall debt and repaid in the same way. The loan fee is not, however, included in the cap of just under $100,000.
Strategies for managing FEE-HELP debt
The strategies for repaying a FEE-HELP debt are the same as for HECS-HELP: basically, don’t repay the debt until the taxation office makes you do so. The reasoning is also the same: no interest is charged on the debt (it is simply indexed to inflation) and so there is almost always a better use of money that would be used to accelerate repayments.