NZ Herald 10 September 2005

AI surrender.

This sort of question has come up every year or two in this column. Until now, I’ve questioned whether it’s ethical to take out a student loan that you don’t need, with plans to invest the money during the interest-free period while you are studying and pay it back when the interest bills commence.

An example is what I wrote last year: “Only well-off students can invest their student loans. The government shouldn’t be helping them out, when poorer students can’t take advantage of the situation.”

And earlier this year: “It means that taxpayers are subsidising (students’) investment. Is that fair?”

Now, though, both Labour and National have said they will make the student loan scheme more generous.

And it seems ridiculous to expect people not to make the most of it. When Father Christmas hands out presents, is it reasonable to ask children who don’t really need them not to take them?

Labour’s scheme is particularly appealing to students. If Labour wins the election, it will get rid of interest payments altogether.

Financially smart students will borrow as much as they can, invest whatever they don’t need, and pay back the loan as slowly as possible.

Under National’s promise, interest payments will be tax deductible against earned income. That will effectively reduce interest by about a third or a fifth — depending on your tax bracket — for most students.

If National wins, students should still borrow as much as possible during the interest-free period while they are studying. But most should probably repay their loans as soon as they start paying interest, even though it will be lower than now.

It depends partly on where you invest the money.

Most of the time, the return on a conservative investment in, say, bank term deposits won’t cover the interest you would be paying on the loan.

If, however, you invest in shares or a share fund, you may get higher returns — on average over the long term — than the interest a National government would charge you.

But beware! Such investments can lose value, especially over the shortish term. With bad luck, you might find your investment is worth less than what you have to repay.

And don’t forget that if you borrow from anywhere to invest, your interest is tax deductible. So, under National, the only advantage of using a student loan after you’ve finished studying would be if the interest rate is lower than elsewhere.

The current student loan rate is 7 per cent — somewhat lower than mortgage rates. But there may be times when it’s higher.

Things get more complicated if, like our letter writer, you’re looking at buying a home or an investment property with a mortgage.

When you apply for the mortgage, the lender will ask about your other debt. They won’t be happy if your deposit is a student loan — even if you’re paying zero interest — because you still have to repay the principal.

I expect most lenders will want you to have at least a small saved deposit. Once you’ve got your deposit, though, you might be able to supplement your mortgage with a student loan.

This would definitely save you money under Labour, and under National while you are still studying.

Even after you stop studying, the after-tax interest under National will almost certainly be lower than mortgage interest if you’re buying your own home — because in that case mortgage interest is not deductible.

On an investment property, however, both the student loan interest and mortgage interest would be deductible. So using a student loan will help only when that rate is lower than the mortgage rate.

And always keep in mind that you must repay a student loan at the rate of 10c for every dollar you earn over $16,588.

You will need to convince a mortgage lender — and, importantly, yourself — that you can repay that as well as your mortgage.

That might get difficult, especially if you are borrowing for a rental property. Could you cope if rents fall; or insurance, rates or mortgage interest rates rise; or you have a long period without tenants?

Property investment disasters happen when less money is coming in than going out.

The situation is quite different if you already have a mortgage when you start studying. Regardless of who wins the election, you should take out the biggest possible student loan and use that to repay your mortgage.

Do check first, though, that you can increase the mortgage again later if you find that you have to repay the student loan faster than your mortgage — which will depend on your income level — and you can’t keep pace with both lots of repayments.

Where does all this leave students who need their student loan to live off? Looking enviously at their better-off classmates, I’m afraid.

Perhaps they can take some comfort from a US study that found, “Working 40 years, high school graduates earn an average of US$1.5 million. That grows to $2.6 million for a bachelor’s degree. You earn what you learn.”

The numbers might be different here, but the fact that graduates earn almost twice as much as non-graduates probably isn’t.

For most people, borrowing to fund their education is an excellent investment — even if they don’t benefit as much as others from the government’s largesse on interest rates.

PS. If you want to borrow $1000 in course-related costs, you have to give written proof of those costs, so you can’t invest that money as such.

But if you have other money you would have used for those costs, you can of course invest that.

ACapital + Merchant is listed on both www.interest.co.nz and www.depositrates.co.nz.

But given that I’ve had a couple of inquiries like this — and the websites are helpful for anyone making fixed interest investments — perhaps some tips on using the websites would be useful.

On www.depositrates.co.nz, use the Deposit Rates Calculator. Insert the amount you want to invest and the term of your planned investment, and click, “Show me the rates”.

Unfortunately, while Capital + Merchant is listed there, it says “NR” for “not rated”.

For other companies, though, there is info about the ratings at the bottom of the page.

You’ll have better luck on www.interest.co.nz. On the home page, under “Investing”, click either “Term Deposits less than 1 yr” or “Term Deposits 1–5 yrs”.

You’ll notice that Capital + Merchant has an SQP score of CAC. What does that mean?

Near the top of the page, click “Consumer Guide”, which explains the scores.

CAC is not great compared with other options. When your money matures, you may want to move it to another company with a stronger rating, or a bank.