With £9,000-a-year tuition fees now a reality, many parents are desperate to build uni funds to protect kids from huge debts. But this laudable aim could be throwing away over £20,000.
Many students won't need to repay anything close to the cost of their tuition fees. If that's the case, paying upfront is a waste. This guide show you how it works.
In this guide
A laudable aim gone wrong
"We've a great story. A girl's saved up nearly £30,000, so her parents don't have to borrow for her £9,000 tuition fees. She's a role model."
I almost shivered with fear when a journalist told me this. Bravo for the saving habit, but the idea of this being a role model to follow couldn't be further off the financial mark for many. It's a symptom of the widespread misunderstanding of the changes to English student finance.
No parents HAVE TO borrow for tuition fees - the fees aren't for parents to pay for. First-time undergraduates get them paid for them by the Student Loans Company, and only repay if they earn enough after graduation. (If you're saying "but I don't want my kids to be in debt", please read It's more like an extra tax not a loan in our Student Loans Mythbusting guide).
The nightmare scenario – borrowing elsewhere to fund fees
However, the bit that really scared the bejesus out of me was the thought that her parents, or anyone else's parents, were planning to take commercial borrowing so she didn't have to get a student loan. Here's just a few reasons why student loans are a better system of borrowing than commercial debt:
- Student loans don't go on credit files.
- Student loan repayments are proportionate to income.
- If you lose your job or take time off, so you've no income, you don't need to repay student loans.
- Student loans don't employ debt collectors and won't chase you.
- You can't lose your house if student loans aren't repaid (unlike secured debts).
Structurally, they're far better than other debts, but the interest rate is also relatively low, as it's set between inflation and inflation + 3%, depending on earnings. Over the long run, this is likely to be far cheaper than loans or credit cards.
The only commercial debt that may compete on rate is adding it to a mortgage. But that's only for higher earners, and has its own dangers too. See Should I Shift Debts To My Mortgage?
2014 student loans: the basics
Student loans are a bizarre contradiction. Everyone talks about the price tag, which for many students could be over £50,000 after graduation, once you add up tuition fees and maintenance loans.
Yet the repayment system and interest charges mean that figure bears no resemblance to the actual amount repaid.
Full time students start repaying student loans and the interest in the April following graduation. The repayments are solely based on earnings, not on the amount borrowed. The key fact is...
You repay 9% of everything earned over £21,000, though it's wiped after 30 years, regardless. If you never earn above £21,000, you'll never repay.
This £21,000 threshold will rise with average earning from 2017, so as people earn more, the threshold goes up.
This is just a snapshot of the system.
For a full briefing, read Student Loan Mythbusting – the facts.
The calculations:Many will be paying unnecessarily
Now you know how the system works (if not, read the bit above), the best way to explain why paying upfront could lose you money is to give three example scenarios.
You pay the fees, your child never earns above the threshold
YOU LOSE £27,000
At the maximum £9,000-a-year fees level, the total three-year cost to pay upfront is £27,000. In the extreme case that your child graduates and becomes a low-paid artist, part-time social worker, full-time parent, dies or in any other scenario where they never earn over the threshold, they'd never need to repay a penny.
That means you've paid £27,000 that would have never needed paying back.
You pay the fees, your child has average graduate income
YOU LOSE UP TO £25,500
This is perhaps the most shocking scenario. I'll be honest - when I first did the calculations, I didn't believe the scale of the loss.
The scenario here is a graduate who starts on a decent salary of £25,000 and sees this rise each year at 2% above inflation.
To work out the result, I plugged the data into www.studentfinancecalc.com. It's well worth you playing with it to work out your own scenario and try different assumptions (it's fun, honestly) to see the impact.
(the amount borrowed)
| Total repayment
(factoring out inflation)
|Tuition fee £9,000/year only||£27,000||£23,000|
|Maintenance loan £5,500/year only||£16,500||£21,500|
|Tuition fee + maintentance||£43,500||£23,000|
| This is an estimate designed to show the scale. Use www.studentfinancecalc.com to generate your own answers.
Important: Repayment calculations are based on someone who starts work immediately following graduation and keeps going for 30 years. Any time off from work lowers the amount repaid (and in this case, increases the loss of paying upfront).
Those are the numbers, this is their impact...
- Only planning to borrow fees (not maintenance loan) – LOSS £4,000. Pay upfront and you'd have paid around £4,000 more than the total repayments over 30 years before the debt wipes. (This is calculated at current prices, as by pre-paying you're paying the loan off at current prices).
- Take out the maintenance loan, but pay fees upfront – LOSS £25,500.
The cost of repaying the maintenance loan alone is £21,500, yet getting a tuition fee loan on top only adds £1,500. So that's all it's costing you to add them, in rather than paying £27,000 upfront.
Want to know why repayments are identical for 'tuition fees' and 'tuition fees & maintenance' and only slightly less for 'maintenance only'? It's because monthly repayments are based only on earnings, not borrowing. The maximum repayments on those earnings is £25,000, so adding more borrowing doesn't add to it.
Play with the calculator and it'll soon become obvious.
You pay the fees, your child earns big bucks
YOU GAIN UP TO £26,000
If your child gains employment at a starting salary of £35,000 and sees this rise heavily each year at 4% above inflation, here are the stats:
(the amount borrowed)
(factoring out inflation)
|Tuition fee £9,000/year only||£27,000||£41,000|
|Maintenance loan £5,500/year only||£16,500||£21,500|
|Tuition fee + maintentance||£43,500||£74,000|
This is an estimate designed to show the scale. Use www.studentfinancecalc.com to generate your own answers.
Important: Repayment calculations are based on someone who starts work immediately following graduation and keeps going for 30 years. Any time off from work lowers the amount repaid (and in this case, decreases the gain of paying upfront).
Here's the impact of those numbers:
- Only planning to borrow fees (not maintenance loan) – GAIN £14,000.
Here you repay more than you borrowed, even at current prices, due to the interest (student loan interest rises when you earn above £21,000, reaching a maximum of inflation plus 3% at £41,000 earnings). So paying off the fees if this happens would beat taking out a loan.
- Take out the maintenance loan, but pay fees upfront – GAIN £25,500.
If you pay the tuition fees, but your child takes a maintenance loan, it would cost £21,500 in loan repayments, as well as £27,000 in upfront tuition fees. Taking loans for both would take even longer to repay and add even more interest, costing £74,000 overall instead of £48,500. So you'd gain more by paying the fees upfront.
Safer alternatives to paying off the fees
As the three scenarios above show, for many on low to even relatively high salaries, it'd be a waste of money to pay upfront. But for those on very high salaries, it'd be a big mistake not to.
And that's the problem. This is very unsure, and short of employing a crystal ball it's very difficult to work out what'll happen to your children's future salary. Even someone aiming for a high flying profession like a medicine or the law may change their mind, not get the grades, or opt to work for a charity, go into local politics or decide to become a full-time parent instead.
- Simply put the money aside until you know more about the future
A simple strategy is to put the cash aside in a Top Cash ISA or Top Savings Account until after graduation. Then you'll have a much better idea of earning potential, and whether you should pay off the loans there and then.
There is a cost to doing this. The interest charged to students starting in 2012 or after is inflation (RPI) plus 3% during the time they're studying. However, it'll only be for a few years, and is partially offset by the interest earned on savings.
Weighed up against the risk you'll end up repaying the debt unnecessarily, it's not too large. So putting the cash away until you know the earnings strategy has a cost, but not a huge one.
However, if your child is absolutely, undoubtedly, guaranteed to earn a big salary on graduation, and you have the cash now, then it may be worth avoiding this interest cost.
It's also worth noting that if a graduate has large savings in their name after they leave university, it's possible it could reduce their entitlement to certain state benefits.
- Paying upfront may leave less cash for worse debts
Even if your child is likely to be a high-earning graduate, that still doesn't necessarily make it the best use of your cash.
After studying, many will want to buy a house or perhaps get a loan for a car. (Mature students who've done this already and won't ever need to borrow can skip past this section).
While a mortgage is likely to be at a roughly similar rate to student loans, money used to pay off student loans could provide a substantial deposit that could enable much cheaper mortgage borrowing and save a large amount in the long run.
Plus, when losing a job or taking a break from work, unlike a student loan, mortgage companies will still come asking for the cash and they could take a home if it's not being paid. So reduced mortgage borrowing is likely to be preferable for most.
Compared to a long term car loan or credit card borrowing, the student loan is likely to be substantially cheaper. So using the cash to avoid a student loan, only to effectively borrow back some or all of it from a commercial lender later, isn't a sensible strategy.
However, if you're seriously cash-rich, so you can repay your potentially high earning child's student loan and provide a mortgage deposit and a car without needing to borrow yourself, then it's not such a problem.
The moral hazard
Please don't take this as an essay on why you shouldn't save up for your children. That's not my point. It's whether the use of that cash is best served by paying their student loan.
Of course, my focus has solely been on the clinical financial mathematics. However that isn't the be-all and end-all. People often say they don't like the concept of debt "hanging over them". That's understandable, as it can be a very expensive issue. But it's worth reading this: Think Of It Like An Extra Tax.
There's a second issue here. Some may feel it's a point of principle too. When I write "it's money you may never repay", if you don't repay, of course, someone else has to. That someone else is the UK's Treasury - taxpayers. How that sits with you is a question of your own ethics.