Chipping away at millstone of debt

By JANINE OGIER


Graduates step out into the big wide world of work and grab their first pay cheque with glee.

They are beginning a career and looking ahead to climbing the promotional ladder.

In the meantime, every cent of their pay cheque is probably accounted for in living costs and the expense of enjoying themselves.

The reality of most graduates' finances is a huge debt hanging around their neck. The Inland Revenue Department said about 419,000 people had outstanding student loans at the end of June.

The student loan scheme has been operating for 12 years now and, at graduation, the average loan is about $14,000. It can be much higher for those who make professional choices such as medicine.

Many students do not know the impact their loans will have on their financial life and there's little research available.

Some graduates will be fully aware of the state of their finances and deliberately put it to the back of their mind.

Others may be losing sleep about the interest rate calculations.

Some were likely to have been prudent during their education and limited their loan to the bare minimum.

Then again, human nature being what it is, others borrow as much as they can with scant regard for the consequences.

Debt is such a common concept that people can be complacent.

Whatever the circumstances, as hard as it may be for new graduates to scrimp and save, the responsible step forward is to become debt free.

Once graduates earn over $16,172 a year before tax they are obliged to have loan repayments deducted from their salary.

The minimum annual repayment is 10 cents for every dollar earned over that threshold.

But it is the voluntary repayments off a student loan which will get people into the black ahead of schedule.

The faster a loan is paid off, the less interest is incurred.

A basic premise of financial planning is to pay off debt first before initiating savings or investments.

Basic accounting shows that although student loans do not attract high interest - at the moment the rate is 7 per cent - some people will not be able to get on top of their debt as the minimum repayments will not cover the interest accrued within a given year and the loan will keep mounting.

Others will only be covering the interest accrued and not reducing the principal of the loan, so again they will not make any headway.

Many calculation tools are available on the internet. Try Owe Zero to see how voluntary payments can substantially reduce the time and amount needed to repay a loan.

For instance, the IRD says as little as $10 extra a week can have a real effect on the amount of interest you pay and the term of your loan.

Nonetheless, before making a decision to pay off student debt, people need to consider getting financial advice.

Most financial planners offer a free introductory consultation.

An individual's future plans affect whether it is worth paying off a student loan or not.

For example, a woman who plans to work part-time and raise a family rather than pursuing a regular career may be able to ignore the debt as her income may never exceed the threshold for beginning payment.

Financial planner Simon Hassan, the chairman of the College of Financial Planners, emphasises that people need to prioritise debt repayment.

The first priority should be high interest-bearing debt such as credit cards, hire purchases, and overdrafts. Then come personal loans - before mortgages and student debt.

So while paying off high-interest debt, stick to minimum payments on a student loan, Hassan advises.

From a practical perspective, extra repayments are easy.

Regular extra payments can be deducted directly from your salary or by automatic payment from your bank account.

Lump sum or intermittent payments can be made by sending a cheque to the IRD, by visiting any Westpac branch, or by using the online repayment features of your bank.

A quirk of the system is that if you do make a voluntary payment, you get a second chance to pocket that money.

Voluntary repayments are technically viewed as an overpayment and the law requires the IRD to write to you and give you the opportunity to get the overpayment refunded.

But don't revisit your decision: those extra payments will be valuable when graduates are in their 30s and 40s.

However, one thing to consider in the early repayment decision is political risk, Hassan says.

A future government may scrap the student loan system and waive the outstanding debt.

However, that is a gamble a prudent person might not be prepared to take.

For more information: IRD, Sorted or Financial Planners & Insurance Advisors