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Mortgage Basics

How HECS Debt Can Affect Your Home Loan Application

Unlike most other loans, Higher Education Contribution Scheme (HECS) debts are interest-free. But while student loans don’t accrue interest, they are adjusted for inflation through a process called indexation.

The indexed amount is added to your existing debt on June 1 each year.

In the ten years between 2013 and 2022, this indexation meant student debt grew by an average of 2% each year.

However, this year, Australian consumer inflation spiked. As a result, HECS debts increased by 7.1% – the highest indexation rate in more than three decades.

That, in turn, means someone with an average $25,000 student loan would have seen their student debt increase by more than $1700.

HECS debt and borrowing capacity

When you apply for a home loan, lenders want to know if you can comfortably afford the mortgage repayments. So they look at various factors to determine your borrowing capacity, including your:

  • Income
  • Expenses
  • Existing debts
  • Deposit size
  • Credit history

HECS debt lowers your take-home pay. So it’s considered a liability and factored into the lender’s assessment process, potentially lowering your borrowing capacity.

Generally speaking, the more you earn, the bigger the hit to your borrowing capacity.

That’s because repayment thresholds and rates on HECS debt are determined by income – starting at 1% for those earning more than $48,360 and climbing to 10% for those earning $141,848 and above.

As a result, higher-income earners direct a larger proportion of their salary to repay student debt, leaving a smaller portion available for mortgage repayments.

HECS debt and debt-to-income ratio

Since September 2022, APRA, the banking regulator, made it compulsory for banks to include HECS debt in their debt-to-income (DTI) calculations.

Your DTI compares how much debt you have to how much money you earn, and is typically used by lenders to understand your debt exposure.

A high debt-to-income ratio suggests that a larger portion of your income is already committed to debt repayment, which can make it harder for you to manage additional obligations.

Lenders generally view this as a higher risk, as it increases the chances of you struggling to make timely payments.

Some lenders have maximum debt-to-income ratios for home loan applications. As a result, having a large HECS debt could limit the amount they are willing to lend you.

Should you pay off HECS debt?

Paying off your student debt can mitigate its impact on your borrowing power. But whether doing this is a smart move depends on your individual circumstances.

For instance, if you have other debts with high-interest rates, such as credit cards or a personal loan, it may be better to prioritise paying those off first before clearing HECS debt.

In other cases, it might make more financial sense to put the extra money towards a deposit – particularly if doing so reduces your loan-to-value ratio to below 80% so you can avoid lender’s mortgage insurance.

An expert mortgage broker, like Shore Financial, can help you run the numbers to check if paying off HECS debt is the right move for you.

Five ways to increase borrowing power

While HECS debt can lower your borrowing capacity, there are strategies you can use to mitigate its effects.

These include:

  1. Boosting your credit score by paying your bills on time, reducing outstanding debts, and lowering limits on credit cards.
  2. Looking for ways to increase your income, such as taking on additional work or starting a side hustle.
  3. Saving a larger deposit – as this will reduce the amount you need to borrow, making lenders more willing to approve your loan.
  4. Minimising new credit applications in the months leading up to your home loan application.
  5. Working with a mortgage broker who can provide guidance tailored to your unique situation.

Looking to break into the market? Shore Financial can help. To discuss your options, call us on 1300 416 700, email us on info@shorefinancial.come.au or fill in this online form.


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