We all know that young doctors and dentists typically have quite a bit of HECS debt, which might take years to repay.
How HECS works
When you take out a HECS debt to fund higher education, you don’t need to make any payments on the loan until your income reaches a threshold of $48,361 under the current thresholds. Once your income goes above this level, your employer will start withholding part of your salary.
Your actual repayment rate depends on your income. Repayments start at 1% of your income and increase all the way up to 10% of income above $141,848 per annum.
While there is no actual interest charged on HECS debts, each year the outstanding amount is indexed to inflation. From 2017 to 2021 when inflation was low, the rate of indexation averaged low 1.52%, which meant there was very little reason for making extra repayments.
However, now that inflation is on the rise, the HECS indexation rate is also increasing. Last year the indexation rate jumped up to 3.9% and based on the current inflation rate of 6.8%, it’s likely the rate of indexation applied to HECS this year will be even higher, tipped to come in around 7 per cent.
As inflation rises it makes more sense to make extra HECS repayments., because at a 7% rate of, HECS debt increases will be much higher than the average interest rate on a high interest savings account, or even a home mortgage.
This suggests you should be looking a little more closely at whether you should be making extra HECS repayments.
How indexation is charged
During the financial year, your employer withholds part of your income to cover your HECS repayments. Once the financial year has ended and once you complete your tax return, the ATO runs a calculation to establish exactly how much you owe them, and at that time credits the withheld money against your debt.
This means that even though your employer is taking money out of each pay packet throughout the year, the amount you owe the ATO doesn’t actually reduce until you lodge your tax return – some time after July 1.
The indexation of HECS debts happens each year on June 1 – before the financial year finishes and before you do your tax return. And even though your employer has been holding back part of your salary all year, your outstanding debt amount is still the same as it was at the end of last financial year.
What you need to consider
If you make extra payments on your HECS debt before June 1 of this year, these payments are applied to the debt before the indexation rate is applied. With the indexation rate expected to be around 7 per cent, this gives you a guaranteed return in the short term.
Once you fully pay down your HECS debt, your income will also get a boost moving forward, because your employer will no longer need to withhold part of your pay.
Before you make any decisions regarding repaying HECS or any other debts, you should consider your personal circumstances and seek financial advice.
Please feel free to contact me on 0432 885 295 or Yves@affluenceprivate.com.au for any assistance.
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