Should you repay a student loan early?
A frequent question asked by graduates and parents is whether or not spare capital should be used to repay Student Loans early? The prospect of owing something also became a hot topic for many school leavers deciding on whether to enter a career or attend university.
Student Loans for those who started university from 2012 (in England and Wales) are due to fall in September from 6.3% to 5.4%. These loans are based on inflation plus 3%. Former students who commenced courses before this are either on the Bank of England Based Rate plus 1% (currently 1.75%) or for pre 1998 students the rate of inflation (2.4% in September). The inflation rate is RPI rather than CPI.
Clearly those on the two earlier plans are getting a good deal but if it was as simple as RPI plus 3% for everyone else, there would be a strong argument to repay as it is may even be possible to get an alternative loan for less than the rate charged. It isn’t that simple though!
• The rate only applies up until the April following graduation and then the actual rate depends on earnings. Graduates earning less than £25,725 are charged RPI. Only graduates earning more than £46,305 pay the full rate of interest. Those on an intermediate rate of income pay somewhere in between. For example, someone exactly in the middle earning £35,000 would pay RPI plus 1.5%
• The repayments are based on earnings. If the loan is taken elsewhere a lender is unlikely to allow adjustments to payments if earnings fall or the individual is unable to earn for any other reason.
• Student debt is wiped out after 30 years (or on death) regardless of anything else. On the established repayment rate of 9% of earnings above £25,725 and the interest rate applied, it is estimated that 83% of students will not have to pay their full loan back.
For many, the experience of repaying a student loan early will only offer a psychological benefit. For that significant cohort, it may be financially beneficial not to repay faster than the system demands and to view it simply as a ‘graduate tax’ applied to higher earnings. Furthermore, for those contemplating the choice between University or a career, the idea of having a student loan should not be given more weight than it deserves. In many lines of work graduates will still have a competitive advantage or a greater ability to change careers.
For others, direct entry into work and training may be better. Finally, the idea of University simply being a means to a career is blinkered to the other benefits it may offer to those suited to it.
April 2019 by David Cockling