Parents’ university challenge: Aloan and investment plan
OPINION: Tertiary study comes with a huge financial cost. Not only are there tuition fees, living costs and courserelated costs such as textbooks and computers; there is also the loss of income that could have been earned by working rather than studying.
Study requires considerable personal effort and financial sacrifice. The cost akes sense only if there is some kind of return.
In most, but not all, cases the return is primarily a financial one. Money spent on an education is an investment which comes with an expectation of future financial reward through improved employment prospects and potentially higher future income.
From the point of view of an economist, the decision of whether or not to embark on a tertiary course is determined by a cost-benefit analysis.
It is a matter of quantifying the costs in terms of money outlaid and income foregone, and comparing the costs to the estimated dollar value of future benefits, whether that be additional earning power, increased job satisfaction or some other intrinsic benefit.
Borrowing to finance an education falls into the realm of borrowing to invest and, in that sense, is in the same category as borrowing to purchase a rental property or a business. However, student loans have advantages over other forms of borrowing.
Unless the student goes overseas, no interest is incurred; repayments are made at source by a deduction from income along with PAYE and are linked to the level of income. The lower the income, the lower the repayments.
The effect of these features is that a student loan is more akin to a deferred tax liability than a debt. In other words, the student is effectively committed to a lower level of take-home pay until such time as the loan is repaid.
Student loans are not to be avoided at all cost, nor should they be treated as a burden that needs to be dealt with before buying a house or starting a family.
Because they are generally interestfree, they rank at the bottom of the list in terms of repaying debt. Whether you are a student or a parent of a student, it is better to use an interest-free loan to pay for study than to use your own funds.
Your own funds are better invested elsewhere to earn a rate of return – whether that be in bank deposits, an investment portfolio, or increased repayments on other interest-bearing debt.
Many parents have a strong desire to help their children financially while studying. From a strictly financial point of view, assistance from parents should be limited to what is required over and above the funding that comes from an interest-free student loan. It is better to set funds aside elsewhere to earn a return.
At the end of the study period, the funds invested can be used to repay the student loan if the student intends to go overseas, or to help the student save for a deposit on a house or set up a business.
As noted above, the effect of a student loan is simply to reduce the net income of the student until the loan is repaid. Most mortgage lenders will generally treat a student loan in this way.
A student loan will reduce the borrower’s ability to meet debt servicing requirements, thus limiting the amount that can be borrowed. Instead of repaying an interest-free student loan with a lump sum, use any available funds to increase the deposit and therefore reduce the size of the mortgage.
While interest-free student debt is ‘‘good’’ debt, it needs to be dealt with responsibly. It should only be incurred for essential costs rather than funding luxuries such as skiing trip in Queenstown. It needs to be repaid responsibly so as not to incur penalties, and as with any investment, you need a clear idea of what the returns are.
There is little point taking on debt to fund a course that does not provide tangible benefits, such as improved career prospects, or intangible benefits such as increased job satisfaction. Take advantage of interest-free borrowing but only borrow what you need. Liz Koh is an authorised financial adviser and author of
Awa Press. The advice given here is general and does not constitute specific advice to any person. Adisclosure statement can be obtained free of charge by calling 0800 273 847.