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Should we follow the Kiwis and offer discounts for graduates who pay off their student loans early?

Anyone hoping to get a university place this year is likely to be feeling anxious. With a record number of applicants and universities facing funding cuts, demand is far outweighing supply. At last year's party conference, the shadow universities spokesman David Willetts outlined the Conservative's plan to fund an extra 10,000 places by offering those with student loans a discount if they repaid their debt early.

As the general election looms and the funding crisis deepens, the proposal has come under closer scrutiny. University of Worcester vice-chancellor David Green argues that with savings rates so low, many graduates would make repaying their loans a priority if they were given discounts. However, both the university think-tank Million+ and the National Union of Students have questioned the costings, while the higher education minister David Lammy has described it as "fatuous" in the House of Commons.

The Tories say the policy would encourage early repayments to the tune of 1 per cent of the entire £30bn student loan book bringing in £300m, which they say is enough to fund 10,000 students for three years.

But there are concerns about the estimates. "We've got this thumb-in-the-air figure of 1 per cent of the loan book being repaid but we haven't seen any modelling from the Conservatives," says NUS president Wes Streeting. New Zealand introduced an early repayment discount last April with a similar target and Australia has had a discount since 1996. Both countries offer 10 per cent on any voluntary repayment over $500.

As New Zealand's discount was introduced during the current financial year, no figures are yet available on take-up. However, statistics from the Australian Tax Office – which collects repayments for Australia's Higher Education Loan Programme – are promising. Between 1989 and 2007, 17.8 per cent of the 2.1 million individuals incurring a debt made a voluntary repayment. Of the A$19.5bn (£12bn) of debt incurred during that period, A$1.4bn was repaid voluntarily. A report from Australia's former Department of Education, Science and Training showed that voluntary repayments rose after the discount was introduced and on a year-to-year basis totalled 1 per cent of the total debt accumulated from 1996 to 2004.

Kate Naughtin, a teacher from Victoria, is among those who made an early repayment. "In my first year of university I paid back some of my HECS [Higher Education Contribution Scheme] and received a discount. I had a bit of extra cash due to my grandma passing away and wanted to use it wisely," says the 26-year-old. "My brother also recently paid back all his university fees because he didn't want it over his head."

One reason take-up is perhaps not even higher in Australia is because a much bigger discount is available to those who pay up front. This discount is currently 20 per cent, but was previously 25 per cent.

Megan Bailey, a 26-year-old teacher from Queensland, chose this option. "I paid the fees every semester as I trained because the discount was 25 per cent. I paid them myself as I had a part-time job."

The university lobby group Million+ says even if the discount raises the necessary funds, it would benefit wealthier students and might encourage those who would normally pay their tuition fees up front to take out loans.

"This scheme would reduce the contributions made by wealthier students and graduates and would obviously benefit those who can afford to pay fees up front or pay off their student loans early," says chief executive Pam Tatlow. "In England, 20 per cent of full-time students do not access the loan scheme so this proposal runs a real risk of reducing the cost of higher education to those who are most able to pay,"

Willetts, however, says criticisms of elitism are ignoring the bigger picture. "People who say it only benefits the wealthy are looking at it from the wrong end," he says. "The beneficiaries are young people who want to go to university and we know that many of the extra people applying are from black and minority ethnic backgrounds and families where they are the first to go to university – they will benefit from the extra places."

Bruce Chapman, professor of public policy at the Australian National University and the brains behind Australia's funding system, says those on lower incomes are often better off not making early repayments, even taking the discount into consideration. "A lot of people say it's really unfair because the rich people get a discount. For most people, getting the discount is not a good idea because they are forgoing the interest rate subsidy of a loan that is interest free, but that is a difficult point to get across. You could never get a loan from a bank at these rates, so those who take longer to pay it off are benefiting for longer."

Over time, higher income earners who repay their loans earlier are often no better or worse off, but the discount can be a useful tool in encouraging people to repay more quickly and therefore increasing governments' cash flows, says Chapman.