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24 November 2020
You leave university, looking forward to your future, then spot your student loan statement. There's a sinking feeling as you see £1,000s of added interest. Yet student loan statements can be dangerously misleading. They've led some into making catastrophic financial decisions. For most graduates, bizarrely, interest isn't relevant. Ignore it, and it'll go away.
This unique guide by MoneySavingExpert.com founder Martin Lewis, for English and Welsh students who started uni in or after 2012 (who have what are called Plan 2 loans), turns most people's understanding of student loans on its head – uncovering how the interest really works, whether you should worry or not, and who should be trying to clear it.
Have you seen your income drop due to the coronavirus?
While nothing has structurally changed in the way your student loan repayment works, if you've been furloughed or made redundant, your reduced income means you will repay less or nothing at all.
On Plan 2 (i.e. a student from England or Wales who started uni in or after 2012)? You currently start repaying when you earn above £26,575 a year (£27,295/year from 6 April 2021) – read the rest of this guide to find out how much you will have to repay each month.
Before I get into the grit of this, let me be blunt. My aim isn't to engage or enrage the wider political debate, just to ensure people don't make poor personal-finance decisions because of misunderstanding the system.
Some attack me for this. They see an explanation which sets people's minds at rest akin to a defence of the system. It isn't. While I do believe, IF we're going to ask individuals to pay towards their education, repaying loans in proportion to what you earn through the tax system is the best way, I've never been a fan of the post-2012 set-up.
I believe charging graduates above-inflation interest to fund their education is wrong in principle, even though in practice it has little impact (though with limited resources, I'd put other changes ahead of reforming it - see my 5 changes needed to student loans blog).
The fact too that Governments can retrospectively change the system is wrong – that should be stopped. Many will know I led the charge against the retrospective hike in student loan repayments, and thankfully we won in the end.
Yet my work and my passion is to explain how to make good decisions based on the system that currently operates. And I am happy to subjugate my own views to do that. I refuse to be a party to inflating the toxicity of a system to make a political point, at the cost of making people make bad decisions. So time to forget politics and get practical...
From 1 September 2020, for students from England and Wales who started university in or after 2012, the headline student loan interest rate increased from 5.4% to 5.6%. This is higher than most mortgages, and far higher than students from prior cohorts. So, if you've got some spare cash, should you use it to pay down your loan?
The answer can be complex, so take your time to read it – print it out if needed. While repayment may seem a no-brainer, when it comes to post-2012 student loans, all is NOT usually what it seems.
The jaw dropping fact is the only people who should be overpaying their student loan debt are high earners, free of other debts, who'll never want a mortgage or other loan.
This will seem odd to some. After all, if you started university in 2013, having taken full tuition fees and maintenance loans each year, that's a total loan of £44,000 – and likely an already scary £4,500 interest has been added to your statement.
Explaining why, though, needs knowledge. Yet if I were to sum it up in one sentence:
As this is counter-logical, I'm going to take you through it slowly. So let's start with my six key facts about student loan interest (or if new to this, for a proper beginners guide read my full 20 Student Loan Mythbusters before that).
Student loan interest rates are based on the RPI rate of inflation (the rate at which prices rise). While studying, until the April following graduation, you're charged RPI + 3%. After that it depends on your annual earnings...
- Earn under £26,575 (£27,295/year from 6 April 2021): Interest rate = RPI
- Earn over £47,835 (£49,130/year from 6 April 2021): Interest rate = RPI + 3%
- Earn from £26,576 to £47,835 (£27,296 to £49,130 from 6 April 2021): It rises gradually from RPI to RPI + 3%. For example, earn midway, so £37,205, and your rate'll be RPI + 1.5%
This change is based on the RPI rate of inflation in the year to the previous March. The RPI rate was 2.6% in March 2020, so interest is currently charged at 2.6% to 5.6%, depending on whether you're still studying and how much you earn.
Of course, if in any year March's RPI is anomalously high, you'll pay a high rate for the year – but if it's anomalously low, it'll be cheap for the year. As student loans are repaid over a long period, things usually even themselves out.
PS: Cynics may rightly note that the Government uses the usually higher RPI inflation measure to dictate student loan interest, and often the lower CPI rate to dictate any state pension or benefits increases.
Inflation is the rate at which prices rise – there are arguments about measuring it – but in theory, if you're charged the rate of inflation on a loan, then the loan itself doesn't cost you anything. An example should help...
Irma Scholar takes a £50,000 student loan, enough to buy her 500 trips to the supermarket. The loan interest rate is set at inflation, which over the next 10 years averages 2%.
After 10 years (for ease, assuming she's not repaid anything) £11,000 interest has been added, so she now 'owes' £61,000. This sounds expensive. Yet the price of goods has gone up the same proportion. So the £61,000 still buys 500 supermarket trips' worth of goods.
In other words, the interest hasn't diminished her spending power. She borrowed 500 shopping baskets' worth and owes 500 shopping baskets' worth.
So the 'real' interest cost to you is the interest above inflation. How much above inflation you are charged depends on what you earn, as explained in point 2.
You become eligible to repay your student loan in the April after you leave University. It's worth noting over 30,000 a year mistakenly repay before that (though if it's happened to you, you can claim the money back – see student loan reclaiming for how).
From this point, students must repay loans at a rate of 9% of everything they earn above £26,575 each year - or more technically £2,214 a month (£27,295/year from 6 April 2021). So if you earn £31,575, as that's £5,000 more than the threshold, you repay 9% of it – which is £450 a year.
This means the amount you owe (the borrowing plus interest) never has an impact on what you repay each year. I know people really struggle with this, so let's pick out of the air a current salary of £36,575 (purely done for maths ease as it's £10,000 above the threshold) and look at how different levels of borrowing impact your repayments – though the same principle applies whatever you earn.
- Student loan & interest: £20,000. Your earnings: £36,575.
As you repay 9% of everything above £26,575 your annual repayment is £900.
- Student loan & interest: £50,000. Your earnings: £36,575.
As you repay 9% of everything above £26,575 your annual repayment is £900.
- To get silly to prove a point: student loan & interest: £1 billion. Your earnings: £36,575.
As you repay 9% of everything above £26,575 your annual repayment is £900.
As you can see, changing what you owe – even to the absurd level of £1 billion – simply doesn't impact your repayments (you may find it easier to listen to my BBC Radio 5 Live student finance podcast to understand this).
The repayment threshold is currently set to rise each year in line with average earnings, it rose to £26,575 from £25,725 in April 2020, and from £25,000 to £25,725 in April 2019 (and will rise to £27,295 in April 2021). Moving forward, you'll pay less as your repayments are based on your earnings above the threshold, not interest rates or how big your loan is.
You stop repaying the earlier of when you die, when you've cleared the initial borrowing plus interest, or 30 years from the April after you graduated. Even if you've not paid a penny back, for those who started in or after 2012, the loan is wiped after 30 years (see when the student loan wipes for earlier cohorts of students).
If you haven't fully repaid, that doesn't mean you've defaulted – this system is designed so you contribute in proportion to your financial success after university (see FAQs for more on that). Earn less and you pay less – financially it's a no-win, no-fee system.
This is where things really start to veer away from the obvious. As I've explained, the amount owed (the borrowing plus interest) doesn't change what you repay each year.
In fact the only thing the amount owed changes is how long you'll repay for. The more you owe, the less likely you are to clear the debt within the 30 years. And crucially...
This bizarrely means, for most people, when analysing the financial impact of their outstanding loan, the price tag of what you owe – ie, the borrowing + interest – has very little relationship with 'the cost' – that is the 9% of everything earned above £26,575 (£27,295/year from April 2021) for 30 years.
That simple fact is crucial. In many ways the biggest damage of student loans is psychological, not financial. Many are petrified of the huge "debt hanging over me", even though the system really doesn't work like that.
It's one reason student loan statements are so damaging. For most they bear little resemblance to your actual situation. I'm currently working on a suggested alternative statement which puts people in a better position.
Most people should not look at this like a debt and instead consider it like an additional graduate tax. Indeed it's collected that way, through the payroll, just like tax. I'm not saying it's cheap, just that this is an accurate evaluation of the cost. Look at it like this...
|Up to £12,500||No tax||No tax|
|Between £12,500 & £26,574||20%||20%|
|Between £26,575 & £50,000||20%||29%|
|Between £50,000 & £150,000||40%||49%|
In fact, I very much believe calling it a student loan is a misnomer, and the result of that is confusing, dangerous and leads to bad decisions. I campaigned for years that, akin to similar systems in other countries, we should rename it a graduate contribution. Though I'll stick with the language of loans and borrowing within this article for consistency with the official terms.
Welsh students may have part of their tuition fees paid for by the Welsh Government. That means the amount borrowed is usually substantially less. Yet, including the maintenance (living) loan, it can still be over £30,000. Otherwise the system is very similar.
In this guide I've focused on English examples. As Welsh students tend to have lower borrowing, you will need to earn less to repay in the 30 years before the debt wipes. Factor that in when you're thinking about repaying.
Those who are employed repay their student loan through their wages, and will continue to do so. However, as HMRC and the Student Loans Company now share data on a weekly rather than yearly basis, there will be some changes to how interest is applied and how your balance is shown to you.
For more information on this, see our Hurrah! Student loan accounts to be updated weekly MSE News story.
Yes, you did read that title correctly. Some with a mathematical bent will have probably worked out why from the six need-to-knows; if not let me explain.
Effectively, you only pay any interest if you earn enough to have cleared the amount you originally borrowed within the 30 years. If not, you're just repaying the amount borrowed, not the interest.
Let's work up the income scale here – try not to just jump to your expected income level, as the early examples are useful to understand the concept
Extremely low-income graduate earners
Salary under £26,575 (£27,295 from April 2021) for their working life.
Someone who went to university and then never earned over the repayment threshold within the 30 years wouldn't repay a penny of what they borrowed, never mind interest.
Now please understand, this is an art, not science. I've plotted salaries as if they always grow constantly. But someone could be on a low salary for 10 years and then see it rocket after that. Or vice versa, but it gives you the right scales of magnitude.
This little graph shows you how it works.
There are a couple of other factors too, as well as your earning, that can impact whether you're more or less likely to clear the debt within the 30 years (and thus pay all the interest). These are...
- Borrowing less initially means you're more likely to repay within 30 years. Lower borrowing is usually because of a smaller 'living loan', because you didn't take all you were allowed, you lived at home so less was offered, you were a part-time student, or you had higher family income which means you were entitled to less (see my hidden student loan parental contribution blog on that).
- Time off work means you're less likely to clear within 30 years. This could be due to career breaks, going part-time, periods of unemployment or reduced earnings, maternity and paternity leave etc.
You're allowed to pay extra off your student loan, without penalties, whenever you want. And with what looks scary interest added to statements, this is superficially appealing to many who have spare cash.
The decision for previous generations of students was pretty easy. Most could simply compare the interest rate with what they would earn saving. Yet as I hope you've understood so far, that doesn't apply to most post-2012 starters...
So if you can overpay the loan, here's what you need to consider first (if you haven't read the sections above before getting here, it really is worth doing).
For overpaying to have any impact you need to repay enough that it'd lower the amount you repay within the 30 years. Here's an example to explain the concept (I've kept the sums based on the current repayment threshold of 9% above £26,575, and ignored inflation, interest and pay rises to keep it simple).
Let's imagine you've built up £10,000 in savings and after a few years you use that to reduce your outstanding student loan balance, because you're worried about the 'interest building up'.
As you can see in this case, overpaying £10,000 makes absolutely no difference to your repayments over 30 years, so paying it has no gain for you whatsoever.
In fact, someone recently contacted me who'd done just this on receiving an inheritance. A year after she lost her job, had read this article and realised it was a futile act, and she won't gain at all from overpaying. She contacted me to ask if she could reclaim her cash. Sadly, I had to say no.
Thus overpaying is just throwing money away as it won't reduce what you pay. And that's likely to be the case UNLESS you're...
a) A high earner, likely to clear the loan and interest in less than 30 years. Use the MSE student loan calculator to get an idea of whether you're likely to be in this category.
b) Someone overpaying a very large lump sum, which'll radically reduce the amount owed, so you can clear it within the 30 years or even clear it entirely straightaway.
If these don't apply, overpaying the loan won't save you any money. So don't do it (if you're worried this means you're 'defaulting on the debt', see the Is this encouraging people not to repay debt? FAQ).
To find if overpaying is worth it, it's worth trying to get an idea of how much of the interest you're actually likely to be repaying. Using the MSE student loan calculator can give you an idea, but remember it has to make many assumptions – so is a rough indicator only. Here's how to interpret the results...
a) Is the 'what you repay amount' less than your initial borrowing? If so, you won't be repaying any interest at all, as you won't repay even what you initially borrowed.
b) Is the 'amount converted into today's money' less than your initial borrowing? That means you're paying less interest than inflation, which means in economic terms, holding onto the loan means it's shrinking.
Going back to my shopping baskets analogy... if you borrow £10,000 which buys 100 shopping baskets' worth of money, and inflation increases the price of those shopping baskets to £15,000, but you only need repay £14,000 in real terms, the loan has shrunk.
In both cases, the gain from repaying is likely to be very limited. If you are repaying more than this, so the 'total in today's money' is higher than your original borrowing, then that difference is the real cost of interest to you of the loan.
By definition, as this guide is for those who started university in 2012 or after, there's a long time to go before you hit the 30-year write-off.
So think about whether you're sure you'll stay in your current profession, could you opt out? Take a pay cut? Take time out to bring up a child?
The less certain you are of future solid strong earnings, the more you should hedge towards not overpaying the loan as the downside risk is bigger than the upside gain. If you don't repay the loan and should've done, it's because you'll be a higher earner. Yet overpay now and then have a salary drop, and you may've ended up throwing money away.
Anyone with other expensive debts should certainly pay them off before touching the student loan. Though even if you're debt-free elsewhere, remember...
You might have no debts right now. But it's possible you will have in future, likely for a mortgage or perhaps a car loan, or to set up a business.
By paying off your student loan quicker than necessary now, rather than saving that off, you may need to borrow that amount back via some commercial form of lending later.
It's worth noting, if you unwittingly overpay your student loan, for example as the deductions were taken wrongly, you can reclaim that money. However, if you voluntarily overpay - you cannot ever get that cash back.
Structurally, student loans are the best possible type of lending. You pay in proportion to your income, and if your income drops, so do your repayments. There's no impact on your credit score. They're paid via the payroll (or self-assessment if you're self-employed), so there are no debt collectors chasing and it ends after 30 years regardless. No mortgage, credit card or other loan comes close.
Looking purely at the interest rate – as opposed to the interest you actually repay – since September, many mortgage rates will undercut the maximum student loan interest rate (see mortgage best-buys comparison). Yet the student loan rate changes annually and it isn't always like this. In recent years, for many with middle incomes, the student loan has often been cheaper than most mortgage Standard Variable Rates, though costlier than the best new mortgage deals.
Certainly compared to most personal loans available to new graduates (who tend to have lower credit and affordability scores) student loans are not expensive. Though of course nothing has a lower rate than 0% credit cards, used right – but they're for much smaller amounts.
So if future borrowing's likely, consider building up savings now, rather than speeding up student loan repayments, so you need to borrow less from the bank in future.
My normal answer to 'Should I pay off debts with savings?' is if the debt costs more than the savings pay – clear the debt. And if you use that logic well, ditching the student loan is a no-brainer...
- Student loans charge 2.6% at best, 5.6% at worst, during the 2020/21 academic year.
- The top savings accounts currently pay around 2.75%, but only on small amounts – most top easy-access accounts allowing larger lump sums pay sums around 1.2%.
If only it were that simple. Firstly, the student loan rate changes annually: it may get cheaper (or more expensive) afterwards. Indeed, a couple of years ago many 2012 starters were charged less than savings paid.
Yet even if we ignore that and go on current figures, the only people who can actually do the simple job of comparing savings and student loan interest are the 17% of people who will likely fully clear their debt within 30 years. So...
If not, then frankly it's very difficult to compare, as your savings interest won't be paying close to the headline student loan rate, if anything at all. Even if you are overpaying a lot off your student loan, you have to contrast that against what you would repay over the next 30 years, to see if it'd save you enough to justify it. Any more clarity than that would require a crystal ball, I'm afraid.
So after all this, let me revert to my original point. For big earners, likely to work most of the next 30 years, free of all other debts, unlikely to want or need to borrow anywhere else – overpaying will likely save you money.
I say "tempted", because the Student Loans Company might be writing to you to ask for information, which if you don't supply, puts you on the 'penalty interest rate'. Even though most won't actually pay any interest at all, it's still best to avoid for safety. And of course, because things can change, as you'll read below.
Student loans don't go on your credit report, so don't have an impact on your credit score when getting a mortgage. However, they do impact your ability to repay – if you're earning over £26,575 (£27,295 from April 2021) – because you have lower take-home income.
This comes into play in your affordability score, rather than your credit score (check both as part of the free MSE Credit Club). And its big impact is that the likely amount you can borrow is reduced; though its effect is relatively trivial compared to the big factor – what do you earn?
Of course, if everything else were equal, you've a better chance of getting a bigger mortgage if you're student-loan free. But the practical reality is, to clear the student loan you'd be using savings (I'll assume you're not considering borrowing elsewhere to clear it – that's not a good idea at any time, and especially before a mortgage).
A bigger deposit is crucial for first-time buyers to get a cheap mortgage (see my free First Time Buyers' Mortgage guide). For every extra 5% of the property's value you manage to save, up to 40%, rates tend to get cheaper. So foregoing a bigger deposit to get rid of your student loan would likely cost you. Especially as saving in a Lifetime ISA or Help to Buy ISA means the state will boost your deposit by 25%.
Also, if you're planning to just overpay a little off your student loan, rather than clear it entirely, this won't change the amount of student loan you repay a year (as that's based on what you earn). So in the short term it's unlikely to help you in the mortgage stakes anyway.
Any major, negative, retrospective structural changes to the student loan system are unlikely. Student loans have been running in various guises since 1991 and are all in the same general shape they were when people signed up to them.
More likely than structural change is that some of the thresholds and amounts will differ to what's expected. We've already seen this when the Government froze the repayment threshold at £21,000.
In a letter to the Prime Minister at the time, I explained the biggest issue with that small change wasn't the cost, but that it'd knock future faith in the student loan system, leaving many asking "How can we trust it in future?" And indeed that's happened.
Thankfully, in October 2017, after much lobbying, the Government U-turned and announced it'd increase the repayment threshold to £25,000 – not a small concession. And it's since announced that'll further rise with average earnings every year.
Yet the fact it has played around with the thresholds is concrete proof things can change.
As I've already explained, for most, student loan repayments work like an additional income tax, and indeed this is another symptom of that. Yet for most, unless those changes were extremely radical, it still wouldn't greatly change the fact of whether it is worth overpaying.
So my view is, if under the current system it's likely overpaying the loan would waste money, the chance of that being true is greater than the risk of the system changing so that you should've cleared it.
Having said that, I don't have a crystal ball so nothing is guaranteed. It could even move the other way – after all a new Government could scrap all student loans, retrospectively, and that would mean if you had overpaid it would have been pointless.
Our form of 'income contingent' student loans is explicitly designed so that people should contribute to their education in proportion to the financial success achieved (university is of course much more than just about boosting earnings). And that the state will subsidise those who don't – for example, many nurses and teachers won't repay in full. So not repaying isn't a default; it's that you're not supposed to repay.
That's part of the problem of using the language of debt. People feel they're doing something wrong by not repaying. Calling it a graduate contribution system would improve this.
This is a loan from the state, so the result is the state doesn't get repaid. Though remember the 83% figure is the number of people who won't FULLY REPAY – far, far less won't repay anything at all. Already graduates who started since 2012 have paid back £200 million and they've only been out of uni a couple of years at most.
Initially in 2012, the system was set up with the anticipation that under 50% wouldn't fully repay. They got that wrong, and now it's predicted to be far higher. It was 77% just before the announcement of the repayment threshold increasing to £25,000, and is now 83%. That means this has been nowhere near as successful for the public purse as it was supposed to be.
Yet it still does mean compared to before tuition fees, when the Government simply paid universities by a direct grant, billions are now paid back. Whether that's enough to justify the tuition fees, or if it's caused inflationary issues on universities' costs, is for the politicians to debate.
PS: I've one more thought on this, though it may make your brain hurt. The problem with saying the "taxpayer foots the bill" for what's unpaid, or "the state makes a loss if student loans aren't repaid", is that the whole concept of what SHOULD be repaid is arbitrary.
For example, one way to increase the number of people fully repaying would be to cut the interest rate to the rate of inflation (as it used to be before 2012). Do that and more people would repay in full within 30 years, thus the 'loss' would be reduced. Yet that would mean the total amount the state received would be less, so the taxpayer would actually foot a bigger bill.
Conversely and perversely, if interest rates were increased, and for ease let's be ridiculous and say to RPI + 100%, then almost no graduates would fully clear the loan within 30 years, so the 'loss' would be huge, but the state would take in far more, leaving the taxpayer far better off.
Currently there are no plans to sell post-2012 student loans, but I think it's likely if we continue with a Conservative administration that it will happen. Having said that, the promise is that won't change the practicals for students. You can see my full analysis on this in the letter I wrote as evidence to the House of Lords on the impact of the student loan sale on repayment terms.
Yes, that's very similar. The key question is if you have the cash to pay upfront, would it actually save you money – and that mostly depends on how much you'd be likely to repay (ie, future earnings), not to borrow.
Taking an extreme example, if you never earn enough to repay anything, paying upfront would be a total waste of time. And even if not, building a mortgage deposit is likely to be a bigger financial priority than not taking a student loan and I'd save for that first.
I go into more detail on this in the Should I pay tuition fees upfront? guide, though it's now a few years since I wrote that.
Employees: It's automatically taken from the payroll like tax. HM Revenue & Customs (HMRC) then passes the cash to the Student Loans Company (SLC) every March.
At this point, the SLC applies the repayments as if it had received them on a monthly basis, before interest is calculated, so borrowers don't lose out (though it doesn't look like that to you throughout the year).
If you earn over £26,575 a year (£27,295 from April 2021) and repayments aren't being deducted, it's YOUR responsibility to inform your employer. Ensure you keep evidence of having done this as otherwise it can mean you pay a fine.
While we're on this, if you're new to paying tax, make sure you check your tax code – you could be owed £1,000s if it's wrong.
Self-employed / those with other income doing self-assessment tax forms: You're responsible for notifying HMRC of payments due for student loans when you do your self-assessment form (just like you're responsible for telling it of tax due).
If you have additional income of £2,000+ from savings interest, pensions or shares and dividends, this will also be treated as part of your income so you'll need to repay 9% of that too (provided this plus income is over £26,575 - £27,295 from April 2021) via self-assessment.
The rules state you're still obliged to repay 9% of all earnings above the local equivalent of £26,575 a year (£27,295/year from April 2021). Not doing so could lead to substantial penalties. And this local equivalent isn't just a currency translation, it factors in the cost of living in your country, so it can be radically different.
If we ignore the moral obligation to repay the state for the education it provided you, the real question here isn't "Do I have to?" but "How can they make me?"
This is an issue of enforcement. Certainly if you temporarily leave the UK and come back having missed some payments, expect to be pursued. If you move abroad permanently, never to return, there may be no attempt to pursue you in a foreign court. But there are no guarantees of that.
What's more, the Government has said it will chase people who move abroad more thoroughly than it has in the past – through 'sanctions' and prosecution.
Further information on this is available on the Student Loans Company website, though it's a bit patchy in parts.
As the borrowing is much lower, due to lower tuition fees, they're more likely to repay before the debt clears. Therefore it works more similarly to the pre-2012 student loan system, so for help read the main Should I pay off my student loan? guide.
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