NZ Herald 18 April 2009

AYou’re right on all scores — except that the scheme isn’t limited to $500 repayments.

To catch everyone else up with the play, the government has announced a scheme to encourage people to repay their student loans faster.

Presumably this is because — given that the loans are interest-free for those living in New Zealand — some people have been repaying them as slowly as possible.

Student loan borrowers do have to make some repayments if they live in New Zealand and earn more than a threshold amount, which has just risen to $19,084 a year. Compulsory repayments are 10 per cent of every dollar earned above the threshold. (There’s a different formula for those who live overseas.)

Beyond that, though, some borrowers have figured that if they have any spare money, they will end up better off by putting it in a savings account, where it earns interest, rather than paying extra off their student loan.

The government has now said that if you make voluntary repayments — above the compulsory amount — of $500 or more in an April 1 to March 31 year, they will reduce your loan balance by 10 per cent of the voluntary repayment. If you repay an extra $700, your loan will be reduced by a total of $770. If you repay an extra $20,000, your loan will be reduced by $22,000.

The bonus scheme — which is expected to be passed into law later this year — will apply to payments from April 1 2009 made by anyone living in New Zealand or overseas. After April 1 each year from 2010 on, the government will check if you have made voluntary payments of more than $500 during the previous year — in a lump sum or many payments — and will credit your account for the extra 10 per cent.

To be eligible, you have to be up to date with your repayments obligations. Also, your loan has to have been transferred from StudyLink, which manages student loans while you are studying, to Inland Revenue. So anyone planning to make repayments should wait until that transfer has taken place.

You’re correct in saying that — as long as you live in New Zealand — it’s a good idea to make the voluntary repayments in March, so you can earn interest on the money in the meantime.

There’s also another reason to wait until March. If there’s a chance that your total voluntary repayments over the year might not reach $500, you might want to wait until you have $500 or more so you can get the 10 per cent bonus.

So far we’ve assumed it’s worthwhile to take part in the scheme — if you have the money. After all, a 10 per cent top-up is like a 10 per cent return, after tax and risk-free. You can’t beat that — or can you?

Number crunching shows that in many circumstances you would still be better off saving spare money in a bank account and continuing just the compulsory repayments on your student loan. While your bank account after-tax return will be less than 10 per cent, if the money sits in the account for years, compounding can make this the better option.

Consulting actuary Michael Chamberlain of MCA has come up with a formula to help student loan borrowers living in New Zealand work out where they stand. Subtract $20,000 — the approximate student loan repayment threshold over the next few years — from your salary. Take 30 per cent of the remaining amount.

If the answer is more than your student loan, pay the loan off as quickly as you can, making use of the 10 per cent bonus. If the answer is less than your loan, keep making just the compulsory loan repayments. Recalculate each year. Your time will come!

For example: You earn $50,000. Subtract $20,000 to get $30,000. Thirty per cent of that is $9000. If that is more than your loan, pay it off using the bonus.

Another way to look at it: If you figure that your compulsory payments will repay the loan in full within the next three years, make use of the bonus. If not, don’t.

These calculations assume a before-tax bank account interest rate of 5.5 per cent over the remaining period of your loan. That’s higher than current rates, but lower than a few years ago. If rates rise above 5.5 per cent, paying the loan off fast will be less attractive. If they stay lower, it will be more attractive. But the rule of thumb is a good guide.

There are, of course, other issues at stake too:

• If you are living overseas, you pay interest on your student loan, currently 6.8 per cent. You should definitely use the bonus scheme, paying off as much as possible as fast as possible.
• You might simply dislike being in debt. Fair enough. Make use of the bonus.
• You might want to repay the loan fast to make it easier to apply for a mortgage or other loan — although the fact that you also have money in a savings account should at least in theory cancel that out.
• Nobody knows if a future government could remove the scheme. If you are a “bird in the hand” person, grab the chance while it’s going.

For more info see www.ird.govt.nz/studentloans/.

AI was hoping to challenge first home buyers last week, not to be patronising. Sorry if it came out that way.

I think you have a point about pro-property policy (which in any case makes rather a good tongue twister).

Whenever people propose changes like the ones you have suggested, the standard reply is, “Politicians would never do that. It would lose too many votes.” But I’m not so sure that would be the case if, for example, people realised income taxes could be reduced if capital gains were taxed.

I must say, though, that some of your suggestions would lead to undesirable consequences. And I don’t think we need them anyway. While it’s no longer fashionable to believe in markets righting themselves, I still expect house prices to come back down to their long-term trend in the not-too-distant future.

AI can add to your list of today’s pluses. You can buy furniture and household goods for considerably less now — relative to incomes — than when I bought my first home. Buying a new toaster or table used to be a big deal.

But that’s enough of inter-generation comparisons. They just make people angry.

Thank you for painting an excellent picture of how satisfying it can be to give up some non-necessities for the sake of having your own “little shack”.