The start of a new tax year was marked by the implementatoion of student loan changes announced in last year’s budget. It marked the end of a 10 per cent bonus for voluntary repayments made to your loan balance. The minimum repayment was also raised from 10 cents to 12c in every dollar earned above the $19,000 threshold.
With these changes now in place, an article on Stuff reassesses the smartest method for paying back your student loan:
So what should you do? Nothing at all.
That’s it. You can breathe easy. If you’re a borrower living in New Zealand, the best course of action now is to kick back and let the taxman drag your loan back from your paycheque, cent by measly cent.
The last incentive for making an early repayment has officially gone down the gurgler.
From here on in, it makes sense to repay your loan as slowly as possible. Here’s why.
Inflation is your friend
A $5 note will buy you a lot more right now then it would 10 years down the track.
The Reserve Bank aims to keep inflation running between 1 and 3 per cent, and historical data shows it’s averaged about 2.7 per cent since 2000.
In almost every situation, inflation is your enemy. Each year, it steadily eats away at the true value of the cash in your bank account.
It chips away at your debts too, but that’s negated by the interest that you have to pay.
Student loans are unique, in that they are interest-free for borrowers living in New Zealand.
What this means is that each year, the outstanding balance of your debt shrinks by about 2.7 per cent in “real” terms.
You can use inflation to deliberately eat away at the value of your loan, and turn your spare cash towards much more productive activities.
Let’s say you have a loan of $30,000, and have managed to accumulate the cash to pay it off immediately.
You could pay that back and be debt-free. But 10 years down the track, the same-sized debt would have dwindled to just $24,000 in real terms.
Of course, you’ll be making compulsory repayments along the way. But each year, whatever remains is eroded by an extra few per cent.
Psychological vs Financial
So far we’ve only been considering a purely financial point of view.
Infometrics economist Benje Patterson points out that psychological factors come into play for some people.
“For whatever reason, it makes them feel bad to have it hanging over their head even though its more rational from a financial perspective to actually drag it out.”
He also points out there are three situations where it could make sense to get your loan off your back as fast as possible:
1. If you live overseas, and are therefore accumulating interest.
2. If you intend to travel overseas in the near future, and as such will incur interest.
3. If you’re worried that the Government will reintroduce interest to loans.
Some people in the latter camp might prefer to pay their loan off quick sharp to avoid any risk of getting pinged with interest again.
But Patterson doesn’t expect a u-turn on the interest-free student loan policy from the powers-that-be.
“The Government has ruled it out this term, and I can’t see them going the full hog and reintroducing it any time soon.”
Dunne confirms that the Government has no intentions in that regard. “It probably is politically a no-go area,” he says.
In any case, the best course of action is to put any spare money aside and save it up. That way if the unlikely ever does happen, you can repay your loan instantly.
That is exactly what I planned to do once I’m debt free. I’m going to continue paying my student loan off through my tax at the minimum rate and in the meantime I’m going to start building an emergency fund. Should interest be added to student loans, I would use the amount accumulated in my emergency fund to pay off a lump sum off the student loan because to me, interest being added to my student loan constitutes an emergency!