When you’re gearing up to buy your first home, every financial decision counts, including how you handle your HECS-HELP debt.
Many prospective homeowners wrestle with whether they should pay off their student loans before stepping onto the property ladder. The answer isn’t straightforward and depends on your personal financial situation and priorities.
Let’s look at some of the key factors you have to consider to make an informed choice.
Understanding HECS-HELP debt
HECS-HELP is a loan program that helps eligible students cover their tuition fees.
What sets it apart from other loans is how it’s managed and repaid.
Unlike typical debts, HECS-HELP does not incur interest. Instead, the balance is indexed annually on 1 June, adjusting to the cost of living increases as measured by the Australian Bureau of Statistics’ consumer price index (CPI). This ensures the debt doesn’t lose value in real terms.
For 2024, the projected indexation rate is 4.7%. While this is the second-highest figure in more than a decade, it will likely be a relief from the previous year’s 7.1%.
Impact of student debt on mortgage applications
One of the first considerations is how HECS-HELP debt impacts your ability to secure a home loan.
Although HECS-HELP debt is typically viewed more leniently than other types of debt (like credit cards or personal loans) by lenders, it still affects how much you can borrow. That’s because your student loan repayments reduce your take-home pay.
Your repayment obligations also increase with your income. This, in turn, might reduce the amount a lender will offer you for a home loan.
As such, clearing your student debt before stepping onto the property ladder can improve your borrowing capacity.
Relatively low cost of student debt
Given the low indexation rate compared to typical loan interest rates, the financial impact of carrying HECS-HELP debt is relatively minor.
As such, if you have other debts like a credit card or personal loan with higher interest rates, it might be better to pay these off first.
The money might also be better used towards saving a larger deposit on a home, as this can potentially reduce the need for lender’s mortgage insurance (LMI).
LMI is a type of insurance that a borrower must buy to protect the lender from the risk of the borrower defaulting on their home loan. Typically, it’s required if you borrow more than 80% of the property’s value, meaning your deposit is less than 20%. This insurance does not protect you as the borrower; instead, it safeguards the lender’s interests in case you can’t pay back the loan. The cost of LMI can be substantial and is usually added to the loan amount, meaning you might end up paying interest on it as well.
Opportunity cost
There’s also the ‘opportunity cost’ of paying off your student debt.
Opportunity cost is a concept that refers to the value of the best alternative you give up when you make a choice. It’s essentially what you miss out on when you decide to do one thing instead of another.
This is especially important given the current real estate landscape which has seen Australian home values rise for the 15th straight month in April, according to CoreLogic.
In a rising market, delaying a home purchase to pay off your HECS-HELP debt could mean paying more for the same property later on – potentially costing you tens of thousands of dollars.
Also, if you prioritise entering the property market sooner rather than later, you are investing in an asset that can grow over time. These potential returns could outweigh the benefits of paying off a low-cost, index-linked debt like HECS-HELP.
So what should you do?
Deciding whether to pay off your student debt before buying a home hinges on several factors including your financial health, market conditions, and personal goals.
Given the relatively low cost of HECS-HELP debt due to its CPI-linked indexation, it may make more sense to prioritise saving for a home deposit, particularly in a rising property market.
However, if being debt-free is important to you personally or if you have sufficient funds to manage both objectives without compromising your financial stability, then paying off your HECS-HELP could be the right move as it can increase your borrowing capacity.
An expert mortgage broker like Shore Financial can give you tailored advice based on your unique needs and financial situation.
Looking to get on the property ladder? Shore Financial can help. To discuss your options, call us on 1300 416 700, email us on [email protected] or fill in this online form.
