Today is a revolutionary day. Of the 3.7 million holders of outstanding Student Loans Company loans – many in their 20s and 30s – 400,000 will see their interest rate go negative.
This means in a year, even if they repay nothing, they’ll owe less than now. For the rest, loans are interest-free.
This revolutionary event requires a brain-shift on how we think about debt.
It also means that no-one should overpay more than the minimum required (see the Should I pay off my student loan? guide).
To help, MoneySavingExpert.com has launched a special free calculator, www.studentloanscalculator.co.uk, to work out how long it will take to repay your loan.
Why are the loans starting to shrink?
Every September, the Student Loans Company's annual interest rates are set, based on the previous March's Retail Prices Index (RPI) inflation rate, which includes mortgage costs (see the Student Loans 2009/10 guide).
In the months before this March, we'd seen seismic interest rate cuts.
RPI inflation therefore stood at MINUS 0.4% meaning, on average, the cost of living had fallen over the past year, so loan costs for pre-1998 uni starters' drop today from 3.8% to minus 0.4%, too.
The link with inflation is designed to ensure there's no real cost to student loans as, if you borrow enough to buy a shopping trolley's worth of goods, and as the loan rate rises with other prices, you only repay whatever the same shopping trolley costs. Therefore, borrowing shouldn't diminish your spending power.
How does negative interest work?
With normal positive interest each year, excluding repayments, you owe more; with negative interest, you owe less.
So someone with a pre-1998 loan who has £10,000 outstanding debt, and hasn't hit the repayment threshold, will owe £9,960 at this point next year.
Why don't all student loans get negative interest?
All students who started higher education in or after 1998 will only see their interest rate fall to 0% (from 1.5%).
Yet while interest-free loans sound great, actually, many students could rightly feel diddled. Everyone's rate should be minus 0.4%, but the government exploited a post-1998 loans technicality to prevent this.
As the cost of goods shrink, loans should too. As they won't; it means the 3.3 million holders of outstanding student loans will see their spending power eroded.
The technicality was an exemption added into the rules, which allowed the Government to charge no interest.
While this sounds good, it's been invoked in a year when students would have otherwise benefited from negative interest.
Financially, the impact's small: even on a £10,000 loan, the difference is only £40 over the year.
But the real concern's the principle. Now we've slightly uncoupled inflation and student loan interest, who knows where it'll go in the future?
Top tips for outstanding student loans holders
Surprisingly, many bright graduates say: "It's not costing me much, so I'm going to pay it off." This logic's topsy-turvey.
Even before these changes, student loans were the cheapest long-term debt possible. The following three steps should help everyone decide what to do.
- Step 1: Do you have other debts?
If you have debts, always repay the highest interest-rate borrowing first. If not, your debt will grow faster. As student loans are now, at worst, interest-free, plus guaranteed to stay relatively cheap, they're unbeatable. So always repay outstanding loans, credit cards or a mortgage first.
- Step 2: Savers shouldn't repay student loans any more quickly than needed.
If you're debt-free, the interest that savings accounts pay is more than the cost of student loans. This means you're better off saving than repaying the debt.
What's more, if you're ever likely to get a mortgage for a house, loan for a car or anything else, the interest rate you'll pay then will be a lot higher. So repaying student loans now only to borrow back elsewhere at higher rates later makes no sense.
- Step 3: Find out how long the loan will last.
Check how long it will take you to repay using www.studentloanscalculator.co.uk. All student loans are wiped after a set time, the actual amount depends on when you started higher education, but usually it's by the time you hit age 50 or 60.
This means some of those who earn under the various repayment thresholds may never need to repay – another valid reason not to overpay.
- Step 4: The 'self control' exemption.
The only exception to the 'don't overpay' rule is for those with no self-control. If you’ll just spend or waste the cash, then at least overpaying the student loan is playing safe.
Further reading/Key links
Student loans tool: www.studentloanscalculator.co.uk
Student Loans MoneySaving guide: Student Loans 2009/10
Student loan help: Should I pay off my student loan?
Student finance guide: Student MoneySavings