How to plan for your child's university costs

What size is the university debt bill?

For the academic year 2017-18, students can borrow up to £9,250 to cover tuition fees. They can also apply for a maintenance loan for living costs of up to £7,097 a year if they are living at home, rising to £11,002 a year if living away from home in London – but this is means tested.

Both the tuition and maintenance fee loans accrue interest at the rate of inflation of retail prices index (RPI) plus 3 per cent, from the moment they receive the first student loan payment. The rate used is the previous March's RPI inflation rate and this is updated once a year in September. As RPI hit 3.1 per cent in March – pushed up by the depreciation in sterling – the interest rate on student loans this year will rise to 6.1 per cent. 

Once students graduate they are then charged interest at the rate of RPI inflation until they begin employment. If earning up to £21,000, they continue to pay interest at just the RPI inflation rate. Between £21,000 and £41,000 the interest rate is RPI inflation plus a percentage based on your salary. If graduates earn £41,000 or more, they pay interest at RPI inflation plus 3 per cent.

Graduates don’t have to start repaying their student loan until they earn more than £21,000. The loan repayment is taken directly from their employer via payroll and repaid at 9 per cent of their earnings. This means those who earn a lot after graduating will repay more, with those who earn a smaller amount repaying less. Meanwhile, if the loan is not fully paid back after 30 years it will be cancelled completely.

These features of the student loan mean it differs in important ways from other forms of personal debt. 

"Student debt is expensive, compared with most mortgages and secured loans," concedes Kay Ingram, director of public policy at financial adviser LEBC. "[But] unlike other loans, any outstanding balance is written off after 30 years. Repayments are based, not on what is needed to repay the total over this time, but on the graduate’s earnings in excess of an income threshold. In this respect, the higher interest rate may simply mean that more is written off by the taxpayer over the longer term than is paid back by the graduate."

To pay or not to pay?

One school of thought is that parents and/or grandparents should not pay university fees at all because many students will never have to fully repay them. The Institute of Fiscal Studies estimates that, under the current system, three-quarters of graduates are likely never to pay off their loan in full. 

If, for example, your child ends up in a lower-paid job or takes a career break during the 30-year period after graduation, they may find themselves in this position. In this case, it may be better for parents and grandparents who want to help to concentrate financial support in other ways such as a house deposit or a car, argues Ms Ingram.

"This leaves the taxpayer with a large bill and university finance looking vulnerable, but from the individual point of view paying back a debt that could be written off in the future is a voluntary tax," she says.

Ian Millward, director at Candid Financial Advice, adds: "It’s an enormous sum of money for parents to try to clear. I think it’s better for the student to view it as an additional tax, which will be paid off drip by drip for a very long time. And I think it makes students value the course they’ve chosen, be committed to it and hopefully use it to get a better job [than they would have without the degree]."

There’s also the argument that heading off to university gives young people the opportunity to stand on their own two feet and managing their own finances is part of this process. The experience of taking out a loan and receiving statements on the money borrowed could be a useful skill for your child to develop.

"Regardless of whether parents are willing and able to pay for university, I think there is a good life lesson to be learned by getting children to pay their own way," says Martin Bamford, chartered financial planner and managing director at Informed Choice. "If we fully fund our children through university, they might be financially unprepared when they enter the ‘real world’ and need to take full responsibility for their money management. University can be a good transition between full financial support from parents and flying solo."

But others argue that even if your child never repays the loan in full, the student loan repayments will still have a financial impact on their take-home pay and so there is a reason for parents to help out.

Liz Alley, head of financial planning operations at Brewin Dolphin, says: "To start adulthood with a higher education debt of a possible £56,000, with a punitive 6.1 per cent interest rate, will have a negative knock-on effect for a generation of graduates. Even if they don’t repay it in full, the repayments will burden graduates with a 9 per cent drag on their earnings for the next 30 years."

For example, if a graduate earns £26,000 a year their monthly repayments will be £37.50. Ms Alley points out that if you assume a pay rise of 1.8 per cent per year, over a 30-year period this means they will repay around £35,312 before the debt is finally written off. Someone earning £31,000 a year and making monthly repayments of £75 would end up paying around £53,007 over 30 years. In both these cases, graduates are only paying off the interest, not the loan capital.

And although student debt does not impact a graduate’s credit score, it is considered by mortgage lenders in the affordability checks whichthat

Therefore, it generally makes sense for students to only borrow what they need. And if parents can help them reduce how much they borrow by contributing to costs, for example living expenses, this could be beneficial. Alternatively, students could consider getting a job while they are studying to reduce the amount of money they need to borrow.

And it could also make sense to help pay off the student loan debt early if your child goes on to a high-paying job after graduation and looks likely to maintain this higher income throughout their career.

"With an interest rate of up to RPI plus 3 per cent a year accruing on the amount borrowed, those who will have the earnings potential to repay their loan within 30 years should do so as quickly as possible to save interest payments," explains Danny Cox, chartered financial planner at Hargreaves Lansdown.

Investing to pay off your children’s education

If you do want to help your child pay back their debt, start building up an investment pot as early as possible in order to benefit from stock market gains and ride out any short-term market volatility. Mr Cox suggests putting regular amounts into a stocks-and-shares junior individual savings account (Jisa) from an early age. In the 2017-18 tax year individuals can pay up to £4,128 a year into either a cash or stocks-and-shares Jisa. A child can take control of the account when they’re 16, but can’t withdraw the money until they turn 18.

The principles of investing in an Isa for a child are the same as for an adult and, as with your own pot, the longer you have to build it up, the more adventurous you can choose to be. If you invest in a Jisa when your child is born you will have a long time period to build it up and can take more risk.

"The principles of portfolio picking for a Jisa are the same as for an adult Isa: spread your investment across the markets and sectors where you believe there are decent prospects for the long term and then choose good quality managers to work for you," he says. "The longer the time to invest the more scope there is for parents and grandparents to be adventurous with their investments.

"For newborns the investment world is therefore their oyster, and a higher allocation to smaller companies and emerging markets makes sense, because while volatility may be higher, so are the potential returns on offer for patient long-term investors."

Mr Cox suggests two portfolios, one for those with at least 10 years to save, with a higher allocation to UK smaller companies via Marlborough UK Micro-Cap Growth (GB00B8F8YX59), and a lower-risk portfolio for those with between five and 10 years to build it up. This portfolio is more defensive, with a higher allocation to targeted absolute return funds.

 Danny Cox's suggested medium risk portfolio (5-10 years)

Danny Cox's suggested adventurous portfolio (min 10 years)