Zero Percent

Every year, the New Zealand Government writes off hundreds of millions of dollars from the value of the loans it provides to tertiary student borrowers. It has been doing this for a decade now. Ten years on, it looks like the scheme has done nothing to improve access to tertiary education, to reduce student debt, to reduce debt repayment times, or to discourage Kiwi students from heading abroad. Instead, students leave university with more debt that they take longer to pay off, more overseas based borrowers have outstanding debt, and tertiary enrolment rates have dropped.

What are we doing?

Last week, The New Zealand Initiative released its report on our Decade of Debt. We there argue that the government should reinstate interest on new lending, from 2018. The savings should be put toward measures that improve real tertiary accessibility, like better tertiary preparation at secondary schools with little history of sending kids on to tertiary study.

The report’s drawn a bit of attention and consequently kept me pretty busy last week. I chatted with Mike Hosking on Newstalk before heading over to cover it with Paul Henry.

My more extensive talk with Kathryn Ryan on Radio New Zealand’s Nine to Noon is here; I also chatted with John Gerritsen about it for RNZ’s Checkpoint.

I summarised things in our Insights newsletter.

At the NBR, I contrasted the $602 million interest-rate subsidy with the $504 million in means-tested student allowances targeted at lower income students, and noted a few other problems:

Similarly, without caps on borrowing for living costs, students may be tempted to borrow rather a lot of money at ‘zero percent’ and put the money into term deposits. The scheme would collapse without caps on borrowing. But with caps on borrowing for living costs, students without family resources to rely on have to take on part-time work to cover rising accommodation costs. They would often be better off if they could take on more debt, even at interest, and pay it back when in employment. Instead, these students struggle to juggle employment and study.

The Child Poverty Action Group’s report on student debt, released last week, reaches some similar conclusions. It has further found some students at the bottom have turned to credit card debt to make up the gap between living costs and what they are allowed to borrow at zero percent. The constraints established to keep rich students from rorting the system have real costs for those at the bottom. And more than twice as many students from decile 9-10 schools go on to tertiary study as do students from decile 1-2 schools. Does this make sense?

…It is time to stop seeing the government’s interest-free student loan policy as simply being “bad economics, but good politics.” It is bad for a lot of students, bad for the tertiary sector, bad for tertiary accessibility, and bad for equity. Train-wrecks should not be good politics.

At Interest, I reminded worried would-be borrowers that, under New Zealand’s income-contingent repayment scheme, the only thing that reinstating interest does is lengthen the term of repayments:

New Zealand has an excellent income-based student loan repayment system. Everyone with student loan debt pays a 12% tax on every dollar earned over $19,084 until the debt is paid off. Whether the interest rate is 0%, 2%, inflation plus 3%, or any other percent, the minimum fortnightly payments would not change. What changes instead is the duration of payments. If the interest rate is higher, every dollar borrowed takes a little while longer to pay off. But the fortnightly repayment burden is no different.

How much longer would repayment take? Suppose you left tertiary study with the median student loan balance, inflation adjusted upwards from the most recent stats available: $16,700. And suppose that you followed the typical earnings path for someone with a Bachelors degree, as published in the most recent StudyLink data. Finally, suppose that you paid only the minimum 12% on every dollar earned above the threshold. If the interest rate were 2%, it would take an extra three months to pay off your loan. If the interest rate were 4%, it would take an extra 6 months. At 6%, it would take an extra 10 months. At 8%, 14 extra months. None of these are especially terrifying figures.

Of course, not all investments pay off. The dairy farmer who borrowed at 8% to buy paddocks just before the crash in milk prices might have debt that outstrips the farm’s assets and wind up going bankrupt. And someone taking on tens of thousands of dollars in student debt in pursuit of degrees with little to no chance of employment will take a very long time to pay off their debt, regardless of the interest rate.

Let’s consider a plausible bad case. Suppose you took out $60,000 in student loans for a degree that had no real payoff. Your starting salary winds up being $20,000, then you follow the normal path of annual salary increases after that. Even under zero percent, it would take over 23 years to pay off that debt. Even a 2% interest rate would add four years of repayment. But the problem really isn’t interest, is it? The problem is taking out tens of thousands of dollars of debt for a degree that doesn’t lead anywhere.

And that’s why we recommend a strong refocusing of how government spends its money. If the point of the zero percent policy was to improve tertiary accessibility, and to reduce the student debt burden, the zero percent policy has failed. We suggest better uses for the money currently going toward interest rate subsidies.

Again: we don’t recommend putting interest on existing debt. People signed their loan contracts under certain expectations, and it wouldn’t be right to mess around in that. But we sure as heck could start doing it on new lending as students get better advice about tertiary options.

What’s been most fun since the report came out was watching who provides partisan defences of a failed Labour-National policy, and who thinks things through a little more. More on that to come.

Crossposted from The Sandpit