Student Loans
Should you pay them off?

A whole generation of Brits now have student loans; anyone who started higher education since 1990 was eligible, so that even those who left 13 years ago could still have them! And with the massification of higher education, that means a huge number of people, thus it's not surprising one of the most common questions I'm asked is “Should I pay it off?”

• Student loans are special
• Don't pay it all off
• The best way to repay
• How it affects credit scores
• Isn't 0% cheaper?
• What if I never repay?
• Other articles/discuss

My, how times have changed!

Graduate MoneySaving Checklist
Top Graduates Accounts, First Time Mortgages, Cheapest Gas & Elec, How Interest Rates Work, Problem Debts?, Cheapest Mobile, Food Shopping, Cashback Credit Cards

The answer in a nutshell

In a nutshell, the answer quite simply is no, don't pay off your student loan more quickly than you need to. Student loans are one of the cheapest forms of long term debt possible; by paying them off early you risk needing more expensive borrowing from elsewhere at a later date, plus, use one of the Best Savings Accounts to earn more than the debt costs.

Don't confuse official Student Loans with other student debts

This is only about the official government issued Student Loans Company (SLC) loans taken out while at Uni or college; not any form of personal loan, Career Development Loan, professional studies loan, or loan for students from your bank. For all other types of loan; scrap everything above, treat it like any other type of debt. To find out whether and how to pay off other loans more quickly read Pay Off Debts With Your Savings, Cut The Cost Of Existing Loans and Where To Start With Problem Debts?

Why are student loans special?

Student loans are very cheap debt, in fact, technically you're not actually paying any ‘real' interest, because the interest rate is set at the rate of inflation (see Interest Rates: Beginners Guide). The rate changes each year in September, but its based on the March inflation (RPI) figures.

The rate for 2007/08 is 4.8% ( in 2006/07 it was 2.4%) as March 2007 was a high inflation month, yet in March 2008 the rate was 3.8% so, while it's not yet been confirmed, the interest rate's expected to drop to that soon.

While the system could be fairer, don’t let it bother you too much; in the bigger picture it’s still cheap debt, and over the long run the cost of the borrowing is far less than any commercial debts. It's quite enough to know “this debt is very cheap” to understand the explanation of what to do with it so you could skip straight to the next bit. Yet if you want to understand what ‘no real interest' means read on here…

A quick definition of inflation

Inflation is the rate at which prices rise. Therefore if inflation is 3%, this means things costing a hundred pounds this year will cost £103 next year.

There are two main measures of inflation, the CPI, which is a complex official measure standardised across Europe, and the Retail Price Index (RPI), which measures the value of a large sample of typical goods. The student loan rate is based upon the RPI.

What this means for an ‘inflation rate' loan

Now imagine you borrow £100, and the interest rate you pay is set at this 3% rate of inflation. That means in a year's time you will owe £103. Yet due to inflation, a basket of shopping costing £100 this year will cost £103 next year. Therefore you were lent a 'basket of shopping's worth' of money and still owe a 'basket of shopping's worth' of money, thus your actual spending power hasn't been diminished by the loan and there's no 'real' cost.

Compare this to a higher than inflation rate loan, say 10%, here you'd owe a ‘basket of shopping's worth' plus £7. Hence to repay that money you'd need to forgo £7 of other spending.

Will the government ever charge ‘real' interest for these loans?

This has been mooted in the past by some think tanks, arguing that a commercial rate of interest would generate extra revenue to support higher education. Yet it currently doesn't look likely, and even if it did happen, it's almost certain it would only impact new, not existing loans. So I wouldn't worry too much.

Why shouldn't I just pay it all off?

Based on a pure financial analysis, a loan this cheap shouldn't really be paid off more quickly than is necessary; yet in the real world it depends on whether you're a saver or a borrower.

• If you’re a saver

  The current top savings account rate of roughly 6.3% interest, is higher than this year’s student loan rate of 4.8%; and this is in a year where the rate, as explained above, is abnormally high. Usually the gap between savings and the student loan rate is much bigger.

  Thus, suppose you had a £5,000 student loan and £5,000 in savings. In the top tax-free Cash ISA you’d earn £315 interest, or if that’s used up, in the Top Instant Access Savings account after tax it’d be £250 whereas this year the loan is costing £240.

  Therefore if you used the money in the savings account to pay off the debt you’d be worse off this year, and much worse off in a normal year.

  While there's a gain it isn't huge, yet as a MoneySaving purist I feel obliged to encourage you to profit. Actually for peace of mind, some may feel comfortable with becoming debt-free and I wouldn't argue it too fiercely; unless you’re ever likely to need to borrow… in which case read on.

• If you’re a borrower or are likely to borrow, even for a home

  There is a golden rule for people who have debts, “always focus on paying off the highest interest rate debts first” (see the Should I Pay Off My Debts? and Should I Pay Off My Mortgage? articles.

  Pretty much everything, barring short-term 0% credit card offers, is more expensive than student loans, hence they're the last thing you should pay off.

  Even if you currently only have limited or no debts, most people after leaving university will need to borrow; perhaps a mortgage for a house, to set up a new business, to buy a car. Providing the debt is planned, budgeted for and at the cheapest possible rate there is nothing wrong with doing it.

  Thus if you pay off your student loan quicker than necessary, you may find yourself replacing it in a few years by a more expensive commercial loan, after all, even a mortgage costs more than a student loan.

  Therefore as student loan debt doesn't cost any 'real' interest, it's worth building up your savings now, rather than speeding up student loan repayments, so instead of needing to borrow commercially in the future you can simply use your savings.

  Please do note though, I'm certainly not advocating ignoring the debt or frivolously building up more debt, just not paying this specific debt off quicker than you need to. If you've got spare cash don't spend it, save it and use it to offset future debts.

How much should I actually be repaying?

This depends on which type of student loan you have, but in essence, only repay the minimum you need to. There are two different types; any one who graduated on a course starting before 1998 will have the old 'mortgage-style' type of loan, whereas more recent students will have the new 'income-contingent' type.

• Old Style 'Mortgage Type' Loans

  Here, the April following graduation, you have to start repaying the loan and it operates like a personal loan or mortgage. The amount is worked out so that the loan's repaid in 60 monthly payments over five years (84 monthly payments if you've taken five or more loans). However those who earn under £25,300 a year can defer repayment for 12 months (and if you still earn under the threshold after a year, you can keep deferring).

  Even though the deferment threshold is thankfully high, this is a harsh system; once you do start paying you need to lay out a serious chunk of cash each month.

• New Style 'Income-Contingent' Loans

  Unlike a normal loan, these are in effect a form of graduate tax: you pay a higher amount of income tax until all the money you borrowed has been repayed.

  Currently repayments are 9% of everything earned above £15,000; so earn £16,000 and you'll repay £90 a year, earn £20,000 and you'll repay £450 a year.

  This means the more you earn, the quicker you repay and the less you earn, the more slowly you repay or perhaps you don't ever repay at all.

Does not paying it off impact my credit worthiness?

Credit reference agencies don't hold data on either types of student loan, so if you apply for a new product and are credit scored, the fact you have an outstanding debt shouldn't impact your Credit Score at all.

The only major time it will have an impact is if you're applying for a loan based on your ability to afford to repay, and are asked to provide details of current commitments. As your student loan repayments decrease their assessment of your disposable income, it may affect the maximum cash that they'll offer.

Isn't a 0% credit card cheaper?

Yes, of course it is, 0% is cheaper than anything, and if you're a Stoozer, someone making free cash from credit cards, then things are slightly different.

Yet do remember 0% rates are short term rates that impact your credit score. This is long term debt without any prospect of the rate increasing. You have absolute surety here and it's not really costing you anything. If you like stoozing and want to make money out of credit cards then great, do so, but the best strategy is to do that totally separately from this.

What happens if I never repay or move abroad?

Loans pre-1998 that haven't ever been in arrears are wiped clean 25 years after your repayments started (even if payments have previously been defferred), if you reach the age of 50 (60 if you were over 40 when you started the loan), if you become permenantly unfit to work or if you die.

If post-1998 loans haven't been repaid, possibly due to consistently earning less than the payments threshold, once you reach 65 (for loans taken before September 2006) or 25 years from the first April of graduation (for loans after September 2006) debts are wiped clean. They are also cancelled if you become permenantly unfit to work.

If at anytime you move abroad, you're expected to inform the student loans company so you can make repayments directly to it (usually by direct debit). Your repayments will be deducted in pounds sterling and you'd be responsible for any costs involved in converting the currency.

There are severe penalties if you don't tell the Student Loans Company, or chose not to repay by not providing them with information they request to be able to deduct repayments from your UK salary. These include tripling the normal rate of interest on your account, deducting repayments based on an income equal to twice the UK average earnings, and even demanding that you repay the total loan in one go…so beware!