The pros and cons of paying off Student Loans

We are often asked about the pros and cons of repaying Student Loans. As results day approaches this week, more students will be thinking about taking on a Student Loan, which is used to cover the cost of tuition fees and help towards maintenance costs, but this is a debt that is likely to remain with them long after graduation.

Generally, good financial planning practice would advocate that it’s a very good idea to use surplus income and/or savings to repay your debts as a priority, but does the same rule apply to your Student Loan?

A Little History

Student Loans first became part of the student support package in 1990/91. There have been several changes to loan amounts and repayment styles since their introduction, but a key change occurred in September 2012. Alongside an increase in the fee cap to £9,000, a new Student Loan repayment plan – Plan 2 – was introduced, with a higher earnings threshold, higher applicable interest rates and a longer repayment timeframe. As a result, the average debt among the first major cohort of post-2012 students to become liable for repayment was £32,000.

The total value of outstanding Student Loans at the end of March 2018 reached £105 billion.

Standard Repayment

Importantly, Student Loan repayments are calculated based on what you earn, not what you borrowed. As a result, your chances of fully repaying your Student Loan without intentional over-payments will depend largely on your earnings, as well as your plan type and your outstanding loan amount:

Plan Type	Plan 1	Plan 2
Study Start Date	Pre-September 2012	Post-September 2012
Repayment Threshold	£18,330	£25,000
Repayments Over Threshold	9%	9%
Loan Interest Rate (to September 2018)	1.50%	Between RPI (3.1%) and RPI + 3% (6.1%) dependent on circumstances.

As you can see, although the repayment rates are the same (9%), the threshold income and applicable interest for Plan 1 are both lower than Plan 2. On this basis – if everything else was equal – an outstanding Plan 1 loan would be repaid significantly earlier than a Plan 2 loan.

If you know the basic details of your plan, the Student Loan Calculator can give a good indication of when you might repay your Student Loan (assuming no overpayments), or whether you are unlikely to ever fully repay the debt.

Pros and Cons of Overpayment

Whether or not it is a good idea to overpay your Student Loan will always depend on your personal circumstances and finances, but some key things to consider are:

• Where is the money coming from? If parents/grandparents are willing to help you to write-off your Student Loan by way of a gift, then there are no real downsides to accepting. However, if you’re using your own funds, the money could potentially be put to better use.
• Are you thinking of buying a house? Saving surplus income towards a deposit will mean that you get a better “Loan to Value” ratio, leading to a better mortgage rate. Although mortgage interest rates can be lower than the interest on your Student Loan, the value of the mortgage is likely to be significantly higher, meaning that you could still be better off in monetary terms by not overpaying your Student Loan and using the money towards a house purchase instead. It’s also important to remember that an outstanding Student Loan will not affect a mortgage application.
• Are you saving enough towards retirement? A recent article in The Telegraph has suggested that those who opt out of their workplace pension scheme in order to pay off student debt more quickly risked a £73,000 retirement shortfall, through a combination of lost employer pension contributions, tax relief, investment returns and compound interest over the long term.
• Will you ever fully pay it off? A recent House of Commons Briefing Paper confirmed that the Government expects only 30% of current full-time undergraduates to repay their loans in full. For the other 70%, the remaining outstanding loan would be written off after 30 years (25 years for Plan 1 loans). Sometimes, even if you were to make overpayments, you might never fully repay your outstanding debt, so it is worth doing the calculations before essentially wasting the money – if you’ve overpaid needlessly, you won’t be able to get the money back!

Effectively, Student Loan repayments can be simplified as an extra 9% tax on graduate income, which for the majority of students will last for many years.

In many cases, the psychological burden can be the hardest thing to overcome, but increasing your understanding of the facts, as well as the pros and cons, can certainly help.

Having a robust financial plan for the future which takes into account any student debt, is a great starting point and we will be happy to help if further guidance is needed. You could also take a look at our Millennial Toolkit!

One final tip – whatever repayments you are making, check each tax year that your deductions are being applied and offset against your debt correctly. We have first hand experience that this isn’t always the case and just because you see deductions via your salary, doesn’t mean that the amount is being correctly allocated by the student loans company!

Please note; this blog has been based on the repayment plans and corresponding rates applying for students in England and Wales, and should not be used for anyone who studied elsewhere.