House Deposit or HECS Debt: What is best?
We have received more questions in the past 6 months about HECS then we have in the past 18 years in providing financial advice.
The most significant change in recent years has been how the debts have been “indexed” at inflation.
For many, many years, we have enjoyed a low inflationary environment with debts being indexed at 2-3% per annum. These changes were not significant enough for students to feel the pinch.
However, on 1 June 2023, the indexation was made at 7.1%in line with inflation, sending student debts soaring. It has been the largest increase since 1990 and expectations are that this year’s rate will be between 4.2% and 4.8%.
Many students that I speak to do not understand what they signed up for, the terms of the HECs debt, what inflation is and how indexation is applied.
The lack of financial literacy has been astounding. It highlights that school and universities are not teaching our younger generations the basic financial literacy skills required to make financial decisions.
However, we are finding that there are thousands of students around Australia now learning more about their HECs debts, as it starts to impact their take home pays each month.
When do I have to repay my loan?
If you need to repay a HECS-HELP debt, the first thing to understand is that all required repayment amounts are based on what is called your ‘repayment income’, which is defined by the Australian Taxation Office and calculated using a particular formula.
You generally have to start repaying your HECS-HELP loan when your repayment income reaches the minimum threshold amount (often called the HECS threshold or HELP threshold), which started at $47,014 for the 2021/22 financial year and starts at $48,361 for the 2022/23 financial year. The amount you must repay is set as a percentage of your annual repayment income.
For example, the table below shows how much you’d have to pay based on various annual repayment income amounts. The ATO says the repayment thresholds and rates are indexed on 1 June each year.
Soaring student loan debts are not just impacting personal cashflow, but now they are reducing home buyers lending capacity by up to $150,000.
We recently had a young person referred to us via a mortgage broker.
This individual has $20,000 HECs debt plus a $20,000 car loan.
These debts impacted this individual in two ways
Borrowing Capacity
Your borrowing capacity refers to the estimated amount that you may be able to borrow for a home loan, calculated generally using your net income (income after tax) minus your expenses.
HECs debt & car loan reduce borrowing capacity by approximately $120,000
Personal Cashflow
Repaying HECs debt and car loan increases cashflow by approximately $800 per week.
The bank offered them $211,000 as a loan to purchase a home.
However, we sat and listened to their situation, where they wanted to purchase a home with their parent.
As they are the only child, the parent wanted to ensure their child was able to get into the property market.
We carefully structured a plan to maximise the Age Pension for the parent, whilst supplementing this with investment income (from superannuation), whilst the child had their debts repaid, deposit for a home, and the bank were now willing to lend $575,000 through our strategy and whilst using a mortgage broker.
Obviously this strategy has come with a plethora of complexities that we are working through, however it highlighted several things for us:
lack of financial literacy
banks no longer providing financial advice or solutions
there is the ability to bring forward future inheritances
complexities with estate planning
complexities with the age pension and gifting rules / granny flat arrangements
the benefits of using a mortgage broker
the benefits of using a financial planner - from an education and strategy perspective.
Rising costs of student loans, increasing house prices, and high mortgage costs are increasingly toxic mix for home buyers.
Many mortgage brokers fall in the trap as to providing financial advice, sometimes in their own interest to get the mortgage across the line and get paid commission.
There is no one size fits all solution.
Should an individual reduce their deposit - to increase how much they can borrow. Or should they consider reducing their borrowing capacity and having a higher deposit.
We had a situation this week, where a couple came in for advice in purchasing a home.
The wife was not working and had a $37k HECs debt.
Should she repay her HECs before they apply for a loan?
We concluded in consultation with their mortgage broker that HECs debt was not included in the borrowing assessment, as her income was not high enough to start servicing the HECs debt.
However, once we reviewed their long term financial objectives, that involved essentially splitting income within a business and family trust structure, it would be beneficial to repay the HECs debt for their long-term financial plan.
Alternatively, the bank of Mum & Dad may be able to support and bring forward future inheritances. However, loans/gifts can potentially cause tax issues, affect social security benefits (Age Pension) and, if not done correctly, create family tensions.
This is mainly where our financial advice plays an important and critical role in conjunction with estate planning lawyers, accountants and mortgage brokers.