Martin Lewis: Should you pay for university upfront or take the new Plan 5 student loan?

In September, the new ‘Plan 5’ loans launch for higher education starters from England. This big change could see many graduates and university leavers repaying far more, so some with savings are, understandably, considering avoiding the loans if they can.

With normal lending, I advocate borrowing as little as possible and repaying as quickly as possible, but student loans aren’t normal loans. So this is a much more complex decision, and getting it wrong could cost you £10,000s…

While some prospective (especially mature) students are lucky enough to have substantial savings, the reality is, in most cases, the people asking this question are parents or grandparents considering whether to help fund university. 

So, I’ve aimed this guide mainly at parents with some money to help (but not those as rich as Croesus, for whom university costs are trivial), though I hope it will still help anyone making a similar decision. The logic in it will also apply to working out whether it’ll be worth overpaying loans later (though I hope to write a standalone guide on that nearer to when the first crop of Plan 5 students are graduating).

And again, let me repeat, before you start do ensure you’ve read the Plan 5 student finance: how it works guide first. I’ve written this assuming you have. 

Many parents worry, or feel guilty about the impact a large student debt will have on their child during their working lives, so decide to fork out the money themselves. Yet… 

'Paying upfront ISN’T a no brainer, some could waste £10,000s.'

So it isn’t something to do just because you can. It needs careful consideration. Let me take you through it…

  1. Ensure there are funds for the parental contribution

    Adequate funds to live off while at university are the first priority. So, before considering reducing the student loan, remember those who can afford to pay something upfront are likely to be the same people whose offspring won’t be given the full living loans. 

    So you may well need money to supplement a low living loan. See Plan 5 student loans parental contribution for more help.

  2. You can either not take the loan, or choose to overpay it at any time

    The student loan has two elements. 

    1. Tuition fees. These are normally paid directly by the Student Loans Company, yet you can just pay, or part pay, directly to the university (contact it for info on how – they don’t all do it the same way).

    2. The Living Loan. Again, there is no need to take this, just indicate how much you want to take on the student finance application form. 

    So, if you choose to, you can avoid some or all of the loan. To reduce the loan, rather than avoid it totally, you can do that either on the tuition fee or living loan element, it makes little difference as the repayment terms are identical.

    This is a year-by-year decision, so if your finances change, and you can no longer afford to pay directly, say for year two, you will be able to take the loans then.

    You can overpay after taking the loan

    If you do take the loan, voluntary overpayments are allowed at any time from the day you take the loan until the day before it is wiped.

    Yet this isn’t reversible, so once it's done you can’t ask for the money back (the rule is different if you have wrongly overpaid, such as your employer taking repayments when it shouldn’t – see student loan reclaims), so only do it if you're totally sure it's the right thing.

  3. This needs to be a clinical decision – remember paying for university is primarily the responsibility of the student/graduate, not the parent

    The student loan system is a political football, with many negative connotations, some justified, some not. This has led to common misunderstandings that scare many. Nightmarishly, I’ve even occasionally heard some parents considering taking out costly commercial borrowing to avoid their child getting a student loan.

    Yet responsibility for paying for university is, rightly, mostly split between the state and the individual who goes - not their parents. Without that, university would only be accessible to those with parents wealthy enough to afford it.

    However the cost is paid after leaving, not up front. The more graduates and university leavers earn after university, the more they are expected to pay (the less, the less they pay). In practice the system works more like income-tax than debt, and if you think about it that way, then just imagine for a moment a parent saying...

    I’m saving so my child won’t pay higher rate tax if they earn enough later.

    That would sound perverse, yet I do hear some effectively say...

    I want to protect my child in case they earn enough so the student loan is costly.

    If that's what you're thinking, especially if you are pushing your own finances to help, as you feel its a moral duty, it's worth just taking a moment to think it through. The other common thing some parents say to me is... 

    I want to help, so that if my child is in a low paying job, they won’t have this huge debt hanging over them.

    If that's what you are thinking, it's worth remembering that those in low paying jobs repay little or nothing (see what counts is what you repay), so don’t think of this as a debt, but better, as it’s called elsewhere in the world, a 'graduate contribution scheme' – where graduates repay in proportion to their earnings.

    Now for those who knew all that, and are contemplating paying upfront because an effective 9% extra tax above £25,000 earnings will be a hefty burden, especially for middle earners, and you’ve spare cash to help  then keep reading. Paying upfront still may not be the right call, but you’re at a decent start point.

    PS I am only looking at the practical financial aspects of whether you take a loan or not. You may have your own moral or political reasons for wanting one option or another. I'll leave that to you.

  4. Why paying upfront (or overpaying later) may be wasted money

    Lets take an extreme hypothetical example just to set the scene of what can go wrong...

    Those who never repay a penny are not as much of an edge-case as people think – sadly it’s all too real for some with long term physical or mental illness. It's also worth noting, if you die or are permanently incapacitated in a way you can’t work again, the debt is wiped (to help in the rare cases where unearned income is above the repayment threshold).

    Yet even if Alex had become a long term low earner, in a hopefully much-loved but poorly paid profession, he may have repaid something, but not as much as he borrowed originally – so even then there could be £1,000s more paid out than he ever paid back – more so once inflation is factored into it.

  5. Could the money be better used to avoid other, worse (future) borrowing

    It goes without saying that student loans are better borrowing than high cost debts, like expensive credit cards or payday loans  but in some ways they beat low-cost loans too. So it’s worth a little crystal ball gazing over your child’s likely financial challenges to come, before using your money to pay directly.

    Student loans are without doubt the best form of formal lending available. Best form, isn’t the same as cheapest (though over the long run they may undercut most other borrowing except 0% credit cards). Best form is about the terms of the borrowing, after all…

     If you don’t earn enough, you don’t repay
     If your income drops, your repayments drop
     If your income drops below the threshold, your repayments stop
     There are no debt collectors, as it’s paid via PAYE
     The debt wipes after 40 years regardless

    You’d be delirious to find a mortgage or other lending on similar terms. Yet you can't find them, so it's important to remember that saving for a mortgage deposit (check out Lifetime ISAs) is often a much bigger early adult life-stage challenge than getting a student loan.

    It's worth considering what future borrowing requirements the soon-to-be student is likely to have  mortgage, car loan, credit card debt, or more. Ask is it worth paying for university now to reduce the student loan, if it means they’ll have to borrow money later on commercial terms via a mortgage, car loan or other debt instead.

    PS see how student loans impact your credit rating and how student loans impact your ability to get a mortgage.

  6. If you’re overpaying to avoid interest, remember there’s no ‘real’ cost

    Now for this point, I really need you to have read the section on how the interest works in the main guide (have I mentioned that already?) – if not, please read that first or this will seem nonsense.

    In theory, the new Plan 5 loans have no real cost, as the interest rate is set, at most, at the rate of inflation.

    That means while the interest added to statements may look scary, especially right now, the long term impact on people’s pockets is diminished. And the fact many won’t pay all the interest means they will pay less in ‘real terms’ than you borrowed. 

  7. The interest looks hideous now, but in future you may be able to earn more in savings than it costs

    The new ‘Plan 5’ loans are being introduced at a terrible time for the interest rate as it’s set at the rate of inflation, and inflation is sky high. In the first academic year that means the rate could be up to 13.5% (though there is a chance it may be lowered).

    Currently, UK base rates are far lower than inflation, so the student loan seems, and is, initially expensive (thankfully though, it’s in the first year, when borrowings won’t be too high – and inflation will hopefully drop rapidly).

    Yet remember that the interest rate will change forty-three times for some (the three years of university, then forty years after), so don’t let your decision be overly skewed because of the current short-term situation.

    There have been past iterations of student loans (like Plan 1) that were also set at RPI interest, and over the years I remember a number of occasions where you could earn more in savings than those student loans cost you, so things will, hopefully balance out somewhat.

  8. Does this feel like I’m trying to put you off? Well, I have deliberately started that way

    I thought long and hard about this, and eventually decided to order it this way because…

    a) Many feel not taking the loan is an automatic no-lose choice. It isn’t.

    b) If you don’t take the loan, you can’t change your mind and reverse engineer it later. Yet if you do take the loan, and change your mind, you can pay it back whenever you want (though you will have been charged interest meanwhile).

    So now I’ve done the ‘take a step back and think carefully’ bit, let’s look at who should be considering paying upfront (or overpaying later).

  9. It's likely future mid to high-earning graduates who should be the ones considering not taking the loan

    First, mentally double check that your funds are plentiful enough to easily meet you and your child’s other and future financial challenges.

    If so, then mathematically paying in full is best for those who are likely to clear in full what they borrow within the 40 years (predicted to be 52% of university leavers), which will tend to be those who:

     Are consistently higher earners over their lifetime
     Are unlikely to take substantial time out of work before the loan’s repaid (think parental leave, travelling abroad, plans to do further study)
     Have lower initial borrowing (so lower tuition fees or living loan)

    To try and give a little meat to this, according to analysis by the Institute of Fiscal Studies you're virtually certain to clear your loan if you're earning £55,000 or more by the age of 30. Yet of course, the real question is how do you know your offspring will be one, which is why my next point is… 

  10. Use a 'halfway house' option to buy-yourself time

    If you're in two-minds and are unsure as to whether it’s worth spending your own cash to pay for your child’s university upfront, there is a halfway house, as I explain in this video…

    Martin Lewis: Why the cost of going to Uni will DOUBLE for many from September
    Embedded YouTube Video

    The clip above has been taken from the The Martin Lewis Podcast, courtesy of BBC Sounds.

    With the halfway house, you don’t pay upfront, you take the full loan, yet you put the money you were going to pay into a top savings account (whether you do it in your or their name is up to you).

    Then wait until after graduation (or leaving university) when you’ll have a much better idea about your student offspring's prospective career and future earning power. After all, things can change a lot in the university years, it may be they started wanting to be a lawyer, but now decide they want to be a beat-poet busker (or vice-versa). Hopefully you’ll have a better idea at this point.

    There is a cost to this ‘buy yourself time’ strategy, if it later turns out best to not take the loan. This is because interest is added to student loans from day one – though some of that will be offset by the savings interest – but if it prevents you wasting a good chunk of your overpayments because things change during the formative university years, it’ll look cheap.

  11. Tempted to overpay? Give yourself wriggle room

    It’s early to write this (as it's unlikely to happen to most until 2026 at the earliest – and I hope I'll publish a full guide on it then), but just a final thought for those who leave university, and then are earning well and have spare cash and want to overpay. Even if you're confident you'll clear the loan within 40 years, without a crystal ball, there's always still a risk.

    Imagine you're a homeowner with a high-paying job. You have savings, so you use them to overpay your student loan. Shortly afterwards, you get made redundant. You cannot get that money back.

    Therefore, you no longer have your savings to fall back on to help with your mortgage repayments, so you have to take out a bank loan at a much higher interest rate (if you can get it with no income) than your student loan.

    As a bare minimum, always leave yourself a cash emergency fund of three to six months worth of bills before overpaying.

  12. The rules could change

    All the above is based on the rules as they stand today. It is worth noting, of course, that things could change. In the past, we’ve heard some propose ending student loans, and even some saying that all should be wiped. If so, not taking a loan would’ve ended up a financial loss.

    Equally, there’s a chance terms could get tougher, see my explanation of what could change. Yet if it did, hopefully there would still be an option to overpay at that point, if you had taken the loan. And that’s just the known unknowns, there are of course unknown unknowns that may change things too.

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