Refinancing your home loan to pay off your HECS debt can be a strategic move to improve cash flow and enhance borrowing capacity. However, it’s essential to understand the implications and assess whether this approach aligns with your financial goals.
Understanding HECS Debt
The Higher Education Contribution Scheme (HECS) and Higher Education Loan Program (HELP) allow Australian students to defer tuition fees, repaying the debt through the tax system once their income exceeds a certain threshold. For the 2023-2024 financial year, the repayment threshold is $48,361, with repayment rates starting at 1% of income and increasing with higher earnings.
Unlike traditional loans, HECS debts are interest-free but are indexed annually to the Consumer Price Index (CPI) to maintain their real value. In recent years, high inflation has led to significant indexation increases, such as a 7.1% rise in 2023. This was widely considered unfair given the timing of indexation aligned with an inflation peak and there is planned change to make this more equitable in future.
Impact of HECS Debt on Borrowing Capacity
When applying for a home loan, lenders consider all existing debts, including HECS, as they affect disposable income and repayment capacity.
Even a low HECS debt balance will reduce net income, especially for higher income earners, effectively lowering borrowing power.
Refinancing to Consolidate HECS Debt
Refinancing your mortgage to include HECS debt involves increasing your home loan amount to pay off the HECS debt. This strategy can offer several benefits:
- Improved Cash Flow
- By consolidating debts, you may reduce overall monthly repayments, freeing up cash for other financial goals.
- Enhanced Borrowing Capacity
- Eliminating HECS repayments can increase your net income, potentially allowing for a larger home loan or open up the possibility of buying an investment property sooner.
Considerations Before Refinancing
While refinancing to pay off HECS debt can be advantageous, it’s crucial to consider:
- Loan Term Extension
- Adding HECS debt to your mortgage may extend the repayment period, potentially increasing the total interest paid over time. It comes down to having a better use for the cashflow that makes sense.
- Equity Requirements
- You need to have sufficient home equity to allow the refinance without incurring costs like Lenders Mortgage insurance.
- Financial Discipline
- Consolidating debts requires commitment to avoid allowing the extra cashflow to disappear into lifestyle without improving your long term financial position.
Insights from Tanya. Refinancing to Pay Off HECS Debt
In one of our recent videos, Tanya shared her experience working with clients to explore the benefits of refinancing their HECS debt. For professionals earning over $125,000, refinancing HECS into a home loan can significantly reduce monthly repayments.
Here’s an example she shared:
- A $50,000 HECS debt for someone earning $125,000 incurs monthly repayments of $780 under the current HECS structure.
- By refinancing that amount into a home loan, repayments drop to approximately $299 per month, freeing up $480 for other financial goals.
This strategy isn’t for everyone – it depends on income, equity, and long-term goals. But for those who qualify, and have a strategic, beneficial use for the extra cashflow it can offer significant benefits.
Conclusion
Refinancing your home loan to pay off HECS debt can be a smart strategic financial decision. However, it’s essential to weigh these advantages against potential drawbacks, such as extended loan terms and the need for sufficient home equity. It’s important to understand if this strategy aligns with your financial objectives and seek advice if needed.
Disclaimer: This article is for informational purposes only and should not be considered financial advice. Always consult a qualified professional before making any investment decisions.