Study loans: take it & spend/invest it09/09/2013
Now when the Finnish government is thinking of structural reforms the student grants and loans are most likely part of the package. The plan is to increase the weight of loan and make some alterations to outright student grants in financing one’s studies. Thus I decided to write about the subject.
At the moment the system works so that each student has a total of 55 months in which they can receive student grant/benefit. This is accounted as taxable income and amounts to about 300€. In addition, per month there is possibility to 200€ of tax-free extra benefit for housing costs. Thus, basically all students receive monthly after tax around 450€ to 500€ from the Finnish state (actually from KELA) by only passing few courses. The money is then de-facto totally non-refundable and without any requirements. One can take benefit of these grants without ever even graduating. Is this kind of incentive mechanism a smart benefit in the bigger picture or wise in the scope of public finances? I don’t think so but let’s enjoy it while it lasts!
The benefits provided for the students from the public finances don’t stop here. Students have also the possibility to have government guaranteed student loans. For each month a student receives the student grant, he/she can have an additional loan of 300€ guaranteed by the government. For a standard study year, with 9 months of so called benefits months, one can thus have 2700€ of student loans. Usually this can be drawn from the bank in one or two lump sums so an aspiring student has the possibility to use it very conveniently for example for a nice TV or a sailing trip. The best thing about student loans is that it is absurdly cheap money as there is an explicit government guarantee backing for the loans. Normal margin demanded by the banks is 0.20% – 0.50%. That’s nothing considering that loan is effectively no more than consumer credit for students! Additionally, there are further perks in taking on student loans.
Of course there is the Finnish standard of tax-deductibility of the interest payment but there is also the tax-deductibility on the actual notional amount of the loan capital. This is not maybe generally known and most student don’t realize how good benefit it is. 30% of one’s student loan notional amount that exceeds 2500€ is deducted in the taxation when one is paying down the debt in 10 years after graduation. Thus, if one has for example taken 5*2700€ = 13 500€ student loans, he/she receives 3000€ in extra “free money” due to the tax benefits, assuming timely graduation, as the tax-deductibility of the notional is only available for students graduating in less than seven years. This effective discount from the notional principal more than covers the interest accrued during the term of the loan, especially taking into account the current rates.
There is hence no point of not taking as much student loans as you can. I have few arguments for this. Firstly, the tax-deduction opportunity is a benefit that is subsidized for you by the public finances. You have time to pay taxes for the benefit of other people in the future without gaining back as much as you deserve so why not take the advantage of the system when you can. Secondly, the money is also, as everything else, relative variable. Euro you receive today benefits you more and is much more valuable now than after you graduate and start earning real money. Thirdly, the student loan amount is small drop in the sea when you buy the apartment from Korkeavuorenkatu and take 30 year 400 000€ mortgage.
In the words of legendary football player George Best: “I spent a lot of money on booze, birds and fast cars. The rest I just squandered.” This is a very good option to what to do with the student loans. Trust me; at least exchange semester gives you a good opportunity to do this with the student loans. Another option is to invest the loans. At the moment the 12 month euribor is 0.55%. Add the loan margin and you pay all-together around 1% in interests. That kind of a return target is not exactly hard to beat. After graduation we will be financial professionals and 1% is nothing we are satisfied with. At least you can have free option and upside by buying some capital guaranteed structured product for example.
So my advice is that no matter what you decide to do with the student loans provided for you, at least you should take full advantage of them. Lever yourself up to the maximum and enjoy or invest! Only thing for one to worry is that he/she graduates in 7 years and will be employed in the future. Then it is easy to pay down the debt and one can benefit from the tax-deductions mentioned earlier. Luckily for us this is not a thing to worry – right?