Mary Holm: Bonus for repaying student loan

Could you please explain the new student loan repayment bonus scheme in your business column?

As I understand it, if you can pay $500 extra towards your student loan per year, the government will cancel a further 10 per cent ($50) of your loan. I assume that, since student loans are interest-free, it would be best to do this at the end of the financial year.

You'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 repayment 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/

You said in your column last week: "If you make the choice to rent, please don't moan about it. For a couple on $60,000 the options are there."

Patronising. First-home buyers have every right to moan - housing is vastly overpriced. The bubble is unwinding (thank god), but I am concerned that pro-property policy will slow the fall.

There is an extremely unfair bias in favour of homeowners, banks, investors and real estate agents versus first-home buyers.

This overt preference has resulted in new entrants needing to take on ever-increasing amounts of debt to underpin others' capital gains (and where this is not possible bring in more immigrants).

Affordable housing is easily in New Zealand's grasp, and we could be there in two years if we discourage the speculative premium built into house prices; that is:

* Outlaw negative gearing tax credits. Use the added tax to build more.

* Bring in a blanket capital gains tax.

* Remove withholding tax on savings.

* Increase interest rates back to non-deflated levels.

* Remove self-serving-for-the-rich heritage laws that restrict building supply in desirable areas.

* Reduce immigration.

Put the above policies in place and watch prices plummet. We should all welcome this scenario if we want the younger generation to enjoy the same opportunities we did.

I 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.

In response to your letter from the potential first-home buyer, I bought my first house around 1991 with a 20 per cent deposit, a loan from our parents and bank interest rates of around 14 per cent.

It was hard going, especially because my partner was on contract work which became increasingly irregular, and we were often solely supported by my salary, which at that point was around $20,000.

But we learned some valuable things. Firstly, as long as you can make the mortgage payments, an asset in the hand is worth far more than convenience. That little shack near the beach, although we no longer live there, was purchased for $120,000 and is now worth at least $600,000.

Secondly, you can be happy living in an inconvenient, out of the way place provided that you are willing to accept that there will be a price to pay. We shopped on a very limited budget at 3 Guys, didn't eat or drink out, grew our own veges, didn't have swanky toys, and holidays were spent in a tent somewhere within the range of half a tank of petrol in our only car.

It was hard, but the inconveniences were offset by the security of having our own home and knowing that as long as we paid our loan every fortnight it would remain that way.

I look at the advantages that first-home buyers have today and wonder why no one mentions that these could have mitigated the effect of the latest property boom in some way: Welcome Home loans, working for families for those with kids, interest rates at a third of the early 1990s, lower taxes, rent-to-buy sales, and there are still loans available with less than 20 per cent deposit.

It strikes me that although things may have become worse for first-home buyers in the last five years, actually they have far more options than we did in the 1980s and early 90s.

Also West Auckland is a good place to look for cheap properties right now.

I 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".

Mary Holm is a seminar presenter, part-time university lecturer and bestselling author on personal finance. Her website is www.maryholm.com. Her advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (pref daytime) phone number. Sorry, but Mary cannot give financial advice.