National introduced legislation yesterday that will create a 10% bonus for voluntary repayments of student loans. Repay $1,000 above your compulsory repayments, get $1,100 taken off your loan. Sounds like a good deal. Well, not for people who can’t afford to make voluntary repayments but it’s great for the well-off eh?
Actually, no. Unless your compulsory repayments would pay off your loan in the next year or so, you’re better off saving your money than making voluntary repayments. Check out an example:
Sure, you are free of the loan two years earlier but you’re worse off.
It works at any income and any level of voluntary repayment. At higher interest rates the advantage of saving is even bigger. The only time you’re better to do a voluntary repayment is in the last 18 months or so when the 10% bonus is bigger than the interest.
What reason could National have for offering an incentive that’s not really an incentive? Well, there’s one situation when it makes sense to make voluntary repayments – if there is interest on your student loan. Is that what National is planning? In Parliament yesterday, Trevor Mallard said a source in Treasury had told him that’s exactly what is planned. National insider Richard Long dropped a big hint in his last column.
If you’ve got a loan, the best option is clear. Save your money for now but be ready to pay off as much as you can. Interest on student loans is coming back.
– the mathemagician
UPDATE: Error fixed.