At a conference I attended yesterday there seemed to be some confusion about the government’s plan to index HELP debt at the 10 year bond rate, capped at 6 per cent, rather than at CPI. There was a lot of concern about introducing ‘compound interest’.
In the context of HELP, compound interest is the paying of interest on previously accrued interest added to a student’s debt. This has been a feature of Australia’s income contingent loans, HECS and then HELP, from the start. What’s changing is not the fact of compounding, but the rate of interest. Based on recent history, this is likely to be 1 to 2.5 per cent higher than now.
The main alternative to these variable real interest rates is a loan fee. Undergraduates borrowing under FEE-HELP pay a 25 per cent loan fee. This provides an incentive to pay up-front, avoiding the taxpayer subsidising interest payments on loans from people who have the cash to pay for their education, and contributing to the cost of interest. Upfront payment allows the government to avoid the risk of doubtful debt. However, once the loan fee is incurred it does not provide much incentive to repay early.
The government is removing the FEE-HELP loan fee. It was certainly unfair that full-fee undergraduates had to pay it, but not full-fee postgraduates. HECS-HELP borrowers also make no contribution to the cost of their loan other than the CPI interest.* But I am not sure that the idea of a loan fee should be dismissed. It makes the total cost of higher education more predictable for borrowers, and manages the risks of periods of earning less than the threshold for repayment. At the same time, a loan fee could substantially reduce the cost of HELP to other taxpayers.
* There is something that looks like a loan fee in HECS-HELP, the so-called discount for paying upfront. However the government pays the value of the discount to universities.
Andrew Norton 
Andrew – I think the loan fee you proposed is far better than higher rates of indexation. I figure that the indexation issue will continue to get significant push back given that compounding at a higher rate will see initial “borrowings” dwarfed by indexation amounts in relatively short periods of time – such as career interruptions for family etc. My guess is that we will see the legislative process introduce amendments that lift indexation above CPI but lower than the 10 year bond yields, with the move to government cost of borrowing becoming a longer term adjustment.
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The introduction of compound interest isn’t new but its impact will increase in significance, particularly for graduates who take longer to enter full-time work. Responsible lending standards would be awkward to introduce given that the capacity to repay is based on hypotheticals about future earnings, not on actual earnings or existing personal debt. So in the absence of of debt counselling, education debt looks very like a no-doc loan, and this means many students who are inexperienced borrowers have a very weak sense of their education loan as a real debt. What could change this?
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Certainly the existing indexation compounds in nominal terms, but since the indexation is at CPI it means that the interest rate in real terms is approximately zero, and a zero rate can’t really be said to compound.
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