Rational actions: we’re going to pay off our student loans

Our quest for work outside New Zealand is looking promising enough for us to start thinking about some of the implications of earning our keep abroad. One of them is this: we need to choose whether or not to pay off our student loans.

New Zealand’s support for tertiary students is generous (though chronically underestimated by students). Beyond significant subsidies on tertiary fees, and a means tested student allowance, all tertiary students are able to access student loans to cover fees and living costs.

We both maxed out our student loans. We did this partly because we needed the money, partly to smooth our quality of life between study and work, and partly because it makes economic sense: the loans are interest free so long as you stay in New Zealand. If you invest your loan balance, you’re effectively earning free money!

Over the years we worked in New Zealand, our loan repayments came out of our salaries without us really noticing. We paid back only the minimum and made modest dents. The loans aren’t inflation adjusted, so the longer we take to pay back the less we really pay back. Since we’ve been traveling our loans have incurred interest, but we’ve exercised the year long repayment holiday we’re entitled to.

Now we have a choice to make: we have the means to pay off our loans outright, but is that in our best interests? If we were headed back to New Zealand the answer is no. We’d make minimum repayments again and let inflation erode the real value of our balance. If we never intend to work in New Zealand again, the answer is yes. We avoid interest and get a 10% bonus for lump sum repayments.

For us the situation is slightly more complex. We don’t expect to be away from New Zealand forever. So I was all ready to develop a complex model to establish the tipping point: how many years away before it makes sense for us to pay things off now. This was going to require some pretty gnarly assumptions (future earnings, inflation rates, how we’d earn interest…). Then I did some back of the envelope calculations and discovered the answer is clear enough to not get bogged down in detail.

Even with minimum repayments in New Zealand we’d chew through the rest of our loans pretty fast. Inflation wouldn’t have much time to gobble things up. The 10% repayment bonus for paying now would more than account for any time-value-of-money gains. We’ll be paying things back in full, and soon.

I have to say that this decision making process has challenged a couple of assumptions I had about the student loan policy. First, the loan repayments always felt to me like an extra tax, so automatic that I never really imagined them coming to an end. Second, I’ve generally been a big critic of the interest free loan policy. It skews incentives. Young professionals like us take advantage of the system leaving less tertiary education dollars to go round to folks more deserving than we. I stand by those concerns. But they are slightly blunted by my better understanding of how quickly loans are paid off.

I still argue, incidentally, that there should be progressive repayment thresholds, analogous to our tax system like no repayments up to $20,000 income, 10% up to $40,000, 20% up to $80,000 and 30% beyond. I’m especially keen on this idea because classic criticisms of progressive thresholds (as in tax) don’t easily apply. I doubt progressive repayment thresholds would significantly blunt graduates’ incentive to work hard for more pay. They’re building a career that will outlast the period in which they have to make loan repayments. Think progressive thresholds would encourage grads overseas? Not when they’ll incur interest if they do.

With a policy like that, this whole blog post would have been moot: we’d have paid off our loans before we ever left New Zealand.

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