There is almost £20bn in student loans given out to 1.5 million students, all diligently paying it back through their earnings. But those currently studying, or about to embark on their university career, have a decision to make: pay it off as quickly as possible, or let time take its course.
How does the student loans system work?
In England and Wales, a student loan is generally split into two parts: a tuition fee loan, which covers the cost of your studies, and a maintenance loan, to aid you with the cost of living. For the academic year 2022/23 you could have borrowed up to £9,250 to cover tuition fees. The maintenance loan is means tested – if you live at home you could borrow up to £7,097 a year, which rose to £11,002 a year if you lived away from home in London.
The roadmap to repayment is broken up into five plans. Plan Two covers anyone who started university after 2012. Once you graduate, you will be able to repay your loan over a 30-year period but it's only repayable when you start earning over a certain threshold – the 2022/23 threshold is £27,295. After 30 years, your debt is wiped regardless of what’s left to pay.
When you earn above the threshold, you pay back 9 per cent of everything you earn before tax. Interest is paid on your loans and is increased in line with the Retail Price Index (RPI). As of June 2023, the government has capped the interest rate for all students and graduates at 7.1 per cent.
Here’s an example: Let's say your annual income is £30,000. This means that your monthly income is £2,500. The monthly threshold for repayments is £2,274 (an annual income of £27,295). So as your income is £226 over the threshold, you pay back £20.34 (9 per cent of £226) each month.
However, students who start from August 2023 onwards will have to pay it back over 40 years and will move onto Plan Five. The interest rate for Plan Five will be based on the Retail Price Index and the threshold will start at £25,000. But more on this later on.
This ‘debt’ is markedly different from other types of loans. Myron Jobson, senior personal finance analyst at Interactive Investors, says: “It’s not really considered as debt – when it comes to applying for mortgages. [Lenders] will of course look at your outgoings – and student loans form part of that – but they won’t classify it as debt and it won’t affect your credit rating. Graduates shouldn't feel pressured that they have to get rid of that loan straight away.”
Should you pay off early or save?
Many graduates will never actually pay off their loans and under the current system, only around a quarter will pay off their loans in full, according to the Institute of Fiscal Studies, a think tank. Of course, this will change for future students who pay it back over 10 more years. “Investing in the stock market or just investing more broadly has yielded good positive returns, that has trumped interest applied on student loans,” Jobson says.
Yet this depends on a range of factors. Sarah Coles, head of personal finance at Hargreaves Lansdown, says: “It is people on higher incomes who are going to have the money to pay it back early. If you’re really keen to start investing, you might think I’ll just bear the extra cost over the long term.”
In other words, the student loan can just be treated as a graduate tax. If you want to put any money aside and get on the property ladder, then that might be more important to you than paying off your student loans early.
Why you shouldn’t overpay
By overpaying, you may find that you never pay off the full amount anyway. Therefore, such overpayments would go to waste. According to the MoneySavingsExperts, £106mn was overpaid in the 2019/20 tax year.
Laura Suter, head of personal finance at AJ Bell, added: “You need to be really careful if you do make those overpayments to know that you’re definitely not going to need that money further down the line. You need to make sure that you're not robbing yourself of the ability to have an emergency fund or to deal with some short term spending issues.”
Leap in the unknown
The change to Plan Five shifts the balance somewhat, although it’s important to remember existing students won’t be affected by this. Coles says: “This really tipped the balance as to the number of people who will end up paying it off will increase. A future graduate on a decent salary who is not expected to take a career break, has every chance of having to pay the lot back.”
According to IFS figures, 70 per cent of people will end up paying back their loan in full under the new rules so paying it off sooner could help them later on in life.
