The Federal Government recently announced that the HECS(HELP) annual indexation will increase to 7.1% on 1 June this year. Only two years ago, indexation was a low 0.6%, so most people didn’t give it a lot of thought, however it is now gaining some attention. There is a small window in the next couple of weeks to clear your HECS debt before the HECS indexation of 7.1% is applied on 1 June 2023.
Home buyers who are saving for a deposit are asking whether they should pay down HECS to save on the indexation cost and questioning how that will impact their finance for their future purchase.
HECS impacts finance in multiple ways. The best way to proceed is very much a case-by-case basis.
Borrowing capacity
Banks include HECS as a commitment, generally calculated at the ATO threshold rate as a percentage of income – which is tiered and varies from nil for low-income earners (up to $48,360) to 10% for those over $141,848, e.g. someone on $60,000 would have a commitment of $1,500pa (2.50% of income) included in their loan servicing calculation.
Banks generally allow a maximum debt to income (DTI) ratio of six times. If HECS is included in the debt, it could take a borrower over the threshold.
Available deposit
HECS is generally highest for younger borrowers trying to get into the market and that’s the time when building a 20% deposit is the main challenge for them. Clearing HECS debt is often simply not an option as it would deplete their hard-earned deposit and potentially put them into lenders mortgage insurance (LMI) territory, which erodes any savings from paying out HECS.
Case study
A couple wish to purchase a property to live in for $812,500. They have:
- Income of $120,000 ($60,000 each)
- HECS debt of $70,000 ($35,000 each)
- Available savings to contribute of $190,000
Total required for the purchase (including estimated purchase costs) is $840,000 and their maximum loan (including the HECS commitment) is $650,000, which means:
- Total available for the purchase is $840,000 (loan $650,000 + savings $190,000)
- They are able to buy the property for $812,500, covering 20% deposit + costs so no LMI
| Purchase - with $70,000 HECS debt | |||
| Funds Required | Source of Funding | ||
| Purchase price | 812,500 | New loan^ | 650,000 |
| Government transfer duty | 22,413 | Savings contribution | 190,000 |
| Government registration of transfer | 2,719 | ||
| Government registration of mortgage | 209 | ||
| Other sundry costs conveyancing* | 2,100 | ||
| Total Funds Required (*guide only) | $839,941 | Total Funds Available | $840,000 |
| DTI (Debt to Income) ratio | 6.00 | LVR (Loan to Value ratio) | 80.00% |
In this scenario, although they incur HECS indexation of $4,970 @ 7.1% of their $70,000 HECS debt, they have achieved their primary goal of purchasing their first home.
If they instead paid out their $70,000 HECS debt (to avoid the $4,970 indexation)
- Savings would reduce to $120,000
- Borrowing capacity would improve to $712,000 (without HECS commitment)
- Total available for the purchase would reduce to $832,000
For the same $812,500 purchase, they now have the situation of a $7,941 shortfall. As their deposit is now less than 20%, an extra $12,000 LMI premium will be added to their home loan which would push them over their maximum borrowing capacity.
| Purchase - with HECS debt repaid | |||||||||
| Funds Required | Source of Funding | ||||||||
| Purchase price | 812,500 | New loan^ | 712,000 | ||||||
| Government transfer duty | 22,413 | Savings contribution | 120,000 | ||||||
| Government registration of transfer | 2,719 | ||||||||
| Government registration of mortgage | 209 | ||||||||
| Other sundry costs conveyancing* | 2,100 | ||||||||
| Total Funds Required (*guide only) | $839,941 | Total Funds Available | $832,000 | ||||||
| DTI (Debt to Income) ratio | 5.93 | 80.00% | 87.63% | ||||||
| (Shortfall) | -$7,941 | ||||||||
Although they have saved $4,970 indexation cost by paying out their HECS debt, their goal of buying the $812,500 home is no longer possible!
Paying out HECS is not necessarily the best strategy for this couple’s scenario. A low-income earner with a 20% deposit may be better off keeping the HECS debt intact, as they need their cash to avoid LMI and the impact on borrowing capacity is nominal. However, paying out HECS could work well in some situations, such as couple with a larger deposit who may be better off clearing the HECS debt to improve borrowing capacity and avoid the 7.1% indexation.
In summary, best to seek advice and do the sums before making the decision whether paying out HECS is best for you. For more information, please contact your local BDO Finance Solutions adviser.
* Figures are based on a Queensland property purchase and information as at 10/05/2023.
^ Your full financial needs and requirements need to be assessed prior to any offer or acceptance of a loan product.
Marie Ryan is an authorised credit representative 519653 of BDO Corporate Finance Ltd (ACN 010 185 725) Australian Credit Licence 245513
BDO Corporate Finance Ltd ABN 54 010 185 725 Australian Credit Licence No. 245513 is a member of a national association of independent entities which are all members of BDO Australia Ltd ABN 77 050 110 275, an Australian company limited by guarantee. BDO Corporate Finance Ltd and BDO Australia Ltd are members of BDO International Ltd, a UK company limited by guarantee, and form part of the international BDO network of independent member firms. Liability limited by a scheme approved under Professional Standards Legislation.