The Truth About HECS & What You Need To Know Before Paying It Off Earlier Than You Need To.

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If you were enrolled in an Australian University from 1989 to now, you’re likely to be paying or paid off a Higher Education Contribution Scheme (HECS) debt. Lucky you.

Funnily enough, from 1974 to 1989 university was actually free for eligible students after the Whitlam Government abolished university fees. Their intention was to make higher education more accessible for working and middle-class folk. What a time to be alive! 

Unfortunately, the times of free university education in Australia were shortlived. In 1989 the Hawke Government decided it was not viable due to high participation rates. Subsequently, the HECS system was introduced and has been in place ever since, though with a myriad of amendments. 

Like any debt, you will have to make contributions to pay off your HECS debt. The nuance with HECS is that you’re only required to begin paying it down once you reach a certain income level. But should you be striving to pay off your HECS sooner rather than later? That’s the question I’ve been contemplating for a while and here’s my answer: No. Let me explain why.

Firstly, what is a HECS?

If you want to study at an Australian University or Higher Education Provider, you may be eligible for a HECS-HELP loan (HECS for short) provided by the Federal Government to cover the cost of your tuition.

When do I start paying off my HECS Debt

You need to start paying off your loan once you reach a certain level of income. For the financial year 2020-21, the minimum threshold is $46,620 (this is updated annually), which means that you need to start chipping away at your HECS Debt if you earn $46,620 or higher. If you make between $46,620 – $53,826, you’re required to pay 1% of your annual income towards your HECS. So if you earned $46,620 in FY20/21, you’ll need to contribute $466.2 to your HEC’s for that year. 

If you’re lucky enough to be in a higher income bracket, your repayment rate will also be higher. To see how much you should be contributing, you can check out the 2020-21 HECS-HELP loan thresholds and rates here.

Does HECS Incur Interest?

A HECs debt is likely the cheapest debt you’ll ever receive in your entire life (even with interest rates so low today). But there is truth in the saying that ‘there’s no such thing as a free lunch’. Like a car loan or credit card, the Government does not charge interest on top of your principal student loan. But here’s that catch you’ve been waiting for. Your HECS debt is indexed, which means it’s designed to keep up with the cost of inflation over time. Indexation is applied to your debt to keep it in-line with movements in the cost of living, which is measured by the consumer price index (CPI). The indexation charge is added to your HECS loan on the first of June each and every year. 

So, let’s say your HECS debt was $30,000 on May 31 2019, the next day you’d have an additional $540 added to your HECS obligation ($30,000 x 1.8%), lifting the balance to $30,540. Check out the table below, outlining the indexation rates applied over the years. For this example, I applied the 2019 indexation rate.

Figure 1: Study and Training Loan Indexation Table.

Should you start paying off HEC’s Early? 

As usual, I can’t give you any financial advice. What I say is general in nature only and not specific to your personal situation. But generally speaking, it’s wise to pay off the bad debt incurring the most amount of interest before making voluntary additional repayments into your HECS debt.  

Think credit cards, car repayments, and personal loans. These types of debt can charge astronomically high-interest rates, which are compounding at a much higher rate than your HECS debt. These are the debts you want to rid yourself of first. Because your HECS debt does not incur interest, that should be the least of your worries if you have any of the aforementioned bad debts. 

What if you have no bad debts?

If you have no bad debts and wanted to, you certainly can make voluntary repayments to help pay off your HECS debt earlier. One thing worth remembering is that any voluntary repayments made by you are not tax-deductible. This link will provide you with all the information you need about making voluntary repayments.

Consider Investing Instead 📈

On the contrary, you could invest your money instead of making voluntary repayments to your HECS. Why? Because history tells us that a diversified portfolio of certain index-tracking investments in the stock market has significantly outperformed the average rate of inflation over time.

Let’s go back to our earlier example of a $30,000 HECS debt being indexed at 2019’s indexation rate of 1.8%, adding $540 to your HECS obligation, and compare that to the average return of the S&P 500 index, tracking the return of America’s largest 500 publicly traded companies. Since its inception in 1926, the S&P500 has achieved around a 10% average annual compounded rate of return. With that information in hand, let’s work out the opportunity cost of paying off HECS vs. Investing.

So, let’s say you contributed $10,000 into an ETF tracking the performance of the S&P500 appreciating at its average return of 10% per year. With that kind of return, your $10,000 would turn into $11,000 after one year.

Now, how about instead of investing, you chose to pay down your HECS debt with the same $10,000. As we know already, if you left your HECS untouched, your $30,000 would become $30,540 after indexation. If instead, you paid down your HECS from $30,000 to $20,000 using your $10,000, your debt would become $20,380 after indexation. As you can see, by paying down your debt, the amount added to your total debt once indexation is accounted for becomes smaller ($540 vs. $380). That’s great of course, but let’s look at this a little deeper by throwing our potential returns from investing into the mix.

The Results Are In ⬇️

By choosing to invest instead of paying down your HECS, your loan has gotten bigger by $540, but you’ve managed to generate $1,000 through your investment. To put that into context, you’ve actually earned more through investing than what the debt is increasing by, and here’s the calculation to prove it.

$1,000 (Earned through investing) – $540 (indexation rate added to HECS) = $460 Net cashflow!

Time for a meme ⬇️

The beauty of this approach is that as time passes, and compounding works it’s magic, the gap between the return you make on your investments and the amount you’re charged in indexation will become larger and larger. Check out this table, which explains it much better than I can.

YearsReturn on $10,00 Earning 10% Per Year.Indexation Charge on $30,000 Indexed 1.8% Per Year (assuming no repayments)Net Cash Flow
1$1,000$540$440
2$1,100$550$550
3$1,210$560$650
4$1,331$570$761
5$1,464$580$884
6 $1,611$590$1,021
7$1,771$601$1,170
8 $1,946$612$1,334
Table #1 – Paying off HECS Vs. Investing

This example obviously comes with the caveat that past investment performance is not a reliable indicator of future returns, but 94 years of history isn’t a bad precedent to base our example off. It’s also worth noting that these figures will clearly change depending on what your actual HECS debt is, but I’ll leave it to you to do the math. I’ve done enough math for one day.

With all this share market investing talk, you might be interested in learning more about it. If so, you can check out these free articles to help you along your way. 

  1. 5 Low-Risk Investments Every 20 Something Must Know Of – Pt.1
  2. 5 Low-Risk Ways To Invest Every 20 Something Must Know – Pt.2
  3. A Simple Guide On How to Make Your First Stock Investment in Australia

The Money Pal Verdict

While it’s great to think about paying down your debts, it’s worth your while to consider paying down debt’s incurring a higher interest rate first before worrying about HECS. If you don’t have any high-interest debt, you should think about the opportunity cost of investing versus paying down your student loans. If you need more convincing, just check the table above.

P.S. I’d love to meet you on Twitter: here.

About The Author – Jesse

Hi, I’m Jesse, but you can call me Jes for short. My passion is simple, I’m on a mission to make the world of investing easily understood by removing the ‘too hard basket’ stigma that surrounds it.

Disclaimer:This website (the “The Money Pal”) is published and provided for informational and entertainment purposes only and is general in nature.  The information in this Blog constitutes the Content Creator’s own opinions and it should not be regarded as financial advice. 

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