Yahoo Finance Expert's HECS loophole for Aussies to avoid indexation hit - but you only have a month to act
HECS debts are about to balloon again, but some Aussies could take advantage of a loophole to avoid indexation.
HECS balances are set to rise again this year as indexation is expected to sit at 4.8 per cent. A modest decrease from last year’s eye-watering 7.1 per cent, the upcoming round of indexation on June 1 will still add thousands to outstanding student loan debts across the country.
An outstanding balance of $50,000 will rise by $2,400. A $20,000 balance will rise by $960.
But borrowers who expect to pay off their student loan balance through mandatory repayments this financial year may be able to avoid indexation being applied to their balance by effectively overpaying their debt and getting the excess back as a tax return.
How does HECS indexation work?
The perplexing method used to apply indexation is the great debt debate on everyone’s lips right now.
The short version is that the thousands of dollars you’ve likely paid through compulsory repayments with your employer aren’t taken off your balance when indexation occurs.
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The long version is this.
Student borrowers repay their loan as a percentage of their income, in line with progressively increasing income thresholds.
Their employer’s payroll withholds that money in the same way they withhold tax.
However, those payments are not applied to the actual loan balance until the individual lodges their tax return at the end of the financial year.
As a result, indexation that is applied on June 1 is applied to the borrower’s balance as it stood at the end of the last financial year.
So, if you have an outstanding loan balance of $10,000 and you’ve had $6,000 withheld through your employer for compulsory repayments, you technically only owe $4,000 – but your indexation will be applied to your balance of $10,000.
On this balance, you’ll cop a $480 increase on June 1.
Lump sum repayments to avoid indexation
The loophole of sorts that some borrowers may want to consider is that unlike your compulsory repayments through your income, non-compulsory lump sum HECS repayments are applied in real-time.
In the above example, if you had $10,000 in savings, a lump sum payment to your student loan balance would clear it immediately, meaning you won’t cop any indexation on June 1.
You’d then get the compulsory employer-withheld repayments you’ve made throughout the year back when you lodge your tax return, as these would be surplus repayments.
Generally, it’s borrowers with smaller amounts owing on their HECS balances that will be able to avoid indexation – but if you do have savings on your side, it’s worth exploring whether or not to clear your balance and avoid future rounds of indexation.
Reminder: if you’re making lump sum payments to your student loan balance, be sure to do so well in advance of June 1 to ensure the payment clears before indexation is applied.
It’s important to weigh up what broader goals you have and how best to use any funds you do have available.
If you have a $50,000 loan balance and $50,000 towards a home deposit – that doesn’t necessarily mean paying it down is always the right choice. Consider the opportunity cost of having to save your deposit again – would this cost you more than indexation will? Perhaps.
How HECS debt impacts your borrowing power
Award-winning Gold Coast mortgage broker Maddie Walton explains that many of her first home buyer clients are exploring the possibility of using some of their savings to clear their debt using this method – particularly those nearing the end of their repayments.
“HECS repayments are calculated based on your income and increase the more you earn. In turn, this reduces the disposable income you have available to put towards a mortgage repayment, which is the driver for borrowing capacity," she told Yahoo Finance.
“if you earn $100,000 a year and have a HECS debt, you're in the 6 per cent threshold. Therefore, a bank only considers you earning $94,000 a year.”
The way HECS is repaid means your borrowing capacity is reduced by the same amount no matter whether you have a $10K balance or a $100K balance.
As a result, borrowers who clear their student loan debt using savings increase their borrowing capacity, and get more take-home pay in their pocket.
But, Maddie warns that not all lump sum repayments are beneficial to your home-buying journey.
“If you have a $40,000 HECS balance and pay an extra $20,000 off it, you've done nothing but reduce your deposit by $20,000 and added $0 to borrowing capacity.”
Her rule of thumb? Save your deposit first, and speak to a broker. They’ll be able to run your numbers and look at how your specific HECS situation is impacting your property goals.
