When you leave university and enter the workforce, this may be the first time in your life you have enough disposable income to exercise real choice over how you spend it. You may be asking yourself questions such as:
- Should I pay off my student loan faster, to get out of debt sooner?
- Which should I pay off first - my student loan or my credit card debts?
- Can I pay off my student loan and save at the same time?
- Am I better to pay off my student loan or save for a house?
This blog will attempt to answer all these questions and more - with the help of five handy financial principles.
1. It's ok to treat your student loan differently to your other debts
In New Zealand, a student loan is a unique type of debt. As long as you stay living in New Zealand, you won’t pay any interest on your loan.
This means you can adopt a different strategy to paying off your student loan than you would with any other debt.
With a regular debt, the interest charged means that the debt will grow over time - so your best approach is to pay it off as quickly as possible.
With a student loan, you can relax, safe in the knowledge that your student loan balance is not going to grow. This means there is no incentive to pay it off early - you will have to pay off the exact same figure whether you pay it off this year, next year or in ten years’ time.
With regards to any other debts you may have, the following principle can help get them under control.
2. Always pay off the debt with the highest interest rate first
Your other debts all have one thing in common: they charge interest - which could be anything from about 7% and upwards for a personal loan to over 20% for some credit cards or even 25% for some store cards.
It’s a really good exercise to write down all your debts on a piece of paper, listing how much you owe on each one and what the interest rate is for that debt.
If you prefer to use an interactive tool, try Sorted’s Debt Calculator - which will let you see how much you can save in interest by varying your repayments.
Online or offline, this exercise will help you understand just how much your different debts are costing you. You will be able to see at a glance which is your most expensive debt - the one with the highest interest rate. You can then direct any spare cash you have towards paying off that debt as quickly as possible. Then you can move on to the debt with the next highest interest rate, and so on.
Remember though, that you must always make at least the minimum repayment on all your debts, or you could incur extra charges which will push you further into debt.
3. If you're struggling to keep up with minimum repayments on your debts, seek debt advice urgently
A financial counsellor can offer free, confidential financial advice to help you make a plan to manage your debts. A great place to start is the National Building Financial Capability Charitable Trust website, where you can find budgeting services local to you. These can connect you to a financial mentor, who can help you make a plan to get out of debt for good.
4. Faced with a choice between increasing your student loan payments or saving, save!
Put simply, because you don’t pay interest on your student loan, there is no incentive to pay it back more quickly than you have to. The $10 you owe today will still be $10 in ten years’ time.
Some experts even point out that inflation is working to your advantage here. A $10 note will buy you more today than it will in ten years’ time. Inflation in New Zealand has been running on average at 2.7% since 2000.
What this means is that each year your student loan balance shrinks by 2.7% in real terms - in addition to the amount you are paying off.
So you can use inflation to eat away at the value of your student loan, and turn your spare cash to much more productive activities - such as saving or investing.
5. If you're living overseas, pay off your student loan as quickly as possible
It’s important to remember that student loans are only interest-free while you live in New Zealand. So if you live overseas or you’re planning to travel overseas in the near future, it makes sense to pay off your student loan as quickly as possible to avoid that interest hit.
Here’s the fine print: when you leave New Zealand for at least six months your loan stops being interest-free. But, if you return to New Zealand for less than 32 days in total, these days will count as days spent overseas.
The current interest rate won't apply until you've been overseas for six months or more, but the interest is then backdated to the day after you left New Zealand.
Find out more about paying off your student loan when you’re overseas on the Inland Revenue website.