The arrival of May means it’s budget season.  Both the Federal and Victorian governments will deliver their annual budgets in the next few weeks. Much of the focus will be on initiatives to tackle the cost of living and high inflation.  But as always we watch to see what the governments offer to help with housing – whether that be helping first home buyers, renters or other parts of the market.  It is going to be interesting to see what the respective governments offer. This article will focus on how HECS impacts first home buyers, particularly their borrowing capacity.

Since early this year there has been considerable focus on the Higher Education Contribution Scheme (HECS) and the impact it has on the ability of would-be First Home Owners to borrow. 

The repayment on a HECS debt is based on the gross income of the debt holder. As a person’s gross income goes up so does the percentage of their income that goes towards repaying the HECS debt (HECS Repayment Table). Repayments kick in at the rate of 1% of gross income once a debt holder earns over $51,550 gross pa and increases as income increases up to a repayment rate of 10% of gross income at an income of $151,201 gross pa. 

There is no interest accrued on the HECS debt but each year the HECS debt has always been indexed in line with inflation (using CPI as the index).  

Carrying a HECS debt reduces a first home buyers’ capacity to borrow money as the HECS repayments reduce the disposable income that a home buyer has left to meet home loan repayments.  It is no different to a personal loan or car loan in that respect.  It’s not the size of the debt that matters but the size of the monthly repayment.

A single person on a salary of $95,000 with a HECS debt can borrow around $60,000 less than if they had no HECS debt.  When the max they can borrow is around $400,000, that is a 15% decrease (approximately) in borrowing power. 

The HECS system has been in place since 1989 so this is not a new thing but it has been brought into focus by high inflation rates in the last 2 years meaning big jumps to indexed HECS debts. The result is that in many cases HECS debts have grown even as the debt holder has been making payments on the debt.

This week the Federal Government foreshadowed a change to the indexation system.  Now HECS debts will be indexed by the lower of the Consumer Price Index and the Wage Price Index. This change is being backdated to 2023.  While undoubtedly beneficial to those with debts, the bigger issue is the drag on borrowing capacity that accompanies the existence of the debt in the first place. This week’s announcement will do nothing to address this issue.

I heard one suggestion that banks should come to the party by not considering a HECS debt in the borrowing capacity calculation.  That is a foolhardy, if not dangerous, idea.

The debt and repayments still exist so how can they be ignored? Can the borrower just stop paying the HECS debt if their cash flow does not permit…clearly not.  Also, banks are subject to responsible lending obligations (meaning they need to be satisfied that a loan is affordable to a borrower) so could not do this even if they wanted to do so. Or are people suggesting that banks need not adhere to such obligations any longer when lending money to first home buyers (who are typically the least financially savvy borrowers and need the most protection from predatory practices).

What are the solutions to this challenge?  The government could remove indexation altogether or delay indexation for a period of time (until a course is complete or the debt holder’s income reached a certain level).  

Both options reduce the debt and help with the debt being paid off sooner but neither serve to reduce the repayment which is at least the equal problem. Could the government reduce the repayment rate on the debt? That would help but would also stretch out the debt over a longer term and would increase the total cost of the debt.

I think the solution may lie in Co-equity models for home ownership.  Co-equity products allow a first home buyer to purchase a home with an investment from a 3rd party (government or private business). It allows a buyer to get into the market sooner than they would be able to if doing it all on their own OR to reach a higher purchase price (potentially reducing the likelihood of the buyer outgrowing the home for longer).

The Vic Government has the Victorian Homebuyer Fund that offers to contribute up to 25% of the purchase price in return for an equal share in the property. On the face of it, it’s a great idea but the highly restrictive rules and compliance obligations  (including ongoing income tests) makes the model far less useful than you would hope.  I have not spoken to anyone that has gone with this program. 

If the government can free up the rules then more home buyers will be able to use the program. If not, the government is better placed to work with banks and businesses to help them to develop products that fill this need.

A few businesses have already launched Co-Equity products with more flexibility but also focused on assisting the home buyers (not just First Home Buyers) to select property that is considered to be a sound investment and offer capital growth prospects.  

A key limitation of both the government and business products is the limited number of lenders funding these products.  If banks could get on board with these options then it could be a bona fide way to help more people buy first homes in a sustainable way that is less likely to push up property prices.

Let’s see what May brings!

We hope you enjoyed our article on how HECS impacts first home buyers. For more useful tips and support for first home buyers, visit our knowledge centre here.

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