- New student loan system makes university far more expensive for many
- Only the highest earners will pay off their loan in full
- Someone on a starting salary of £20,000 would only pay off £235 of their loan in their lifetime
- Career breaks, part-time working and re-training will all impact your overall loan amount
Laura Suter, director of personal finance at AJ Bell, comments:
“Many of those going to university next month will find themselves paying off their student loan for longer, paying more interest over that time and facing the ‘graduate tax’ for longer than previous graduates. The loan system changed last year, meaning that today’s university-goers will be on Plan 5 loans, which don’t get wiped out until 40 years after students have graduated, have a lower threshold where people start repaying the debt, but have a lowered interest rate on the loan.
“But the lower interest rate only benefits those who are going to pay off their debt in full, as they will be charged less interest before they wipe out the debt. For huge swathes of people the lower repayment threshold and extra decade of repayments will add thousands to the cost of their student debt.
“Anyone in the fortunate position of weighing up whether to take out a loan or use family money (or their own cash) to pay their way at university instead will have an impossible decision ahead of them. It’s nigh-on impossible to work out whether you’re better off paying your own way at the start of university or repaying your loan when you graduate, either entirely or in chunks of money, or if it’s better to use that cash for something else. It all depends on your starting salary, how much of a pay rise you see over your career, whether you take any career breaks or whether you work part time at any point. It also depends what future governments do with the interest rate you pay on the debt and the threshold for repayments.
“Frustratingly for graduates, they can’t look into the future to see what their earnings will be and whether it’s worth repaying the debt early. If graduates or parents have spare money they could make overpayments but it’s fiendishly complicated to work out if this is actually going to save you money over the term of your loan, or if you’re just throwing money away.
“However, if you know that you’re going to be a high-earner, then paying off the loan when you graduate could save tens of thousands of pounds in interest charges. For Plan 5 loans a starting salary of around £30,000, that gradually increases over the next 40 years, is the tipping point where you’ll end up repaying marginally less than you borrowed. That means for any salaries higher than this you’ll pay off more than you initially borrowed. But there is a huge gamble involved — a career break, a drop in pay, a move to part-time working or a period where your salary plateaus could tip the balance the other way.
“Anyone who never earns more than the repayment threshold, either due to low salary for their entire career or working part time, will never make a loan repayment and so won’t be affected by the recent changes in the system – although the lower repayment threshold will mean fewer people fall into this category. However, the big bulk of middle earners who will never pay off the debt will face tens of thousands of pounds more in repayments over their lifetimes – leading some to question whether the university degree is worth it. Many will be paying off their debt into their 60s and will clock up 40 years of paying a 9% tax on some of their earnings.
“You’ve also got to consider what else you could do with that money. The average student debt is around £50,000 so if you were in the (perhaps unlikely) position of having a pot worth £50,000 available to use you could invest it instead. If you instead invested that £50,000, getting a 5% return a year, you could grow that pot considerably over time. After 10 years it would have grown to almost £81,500 and after 15 years it would be worth almost £104,000. That is a significant pot of money to use for other purposes, whether that’s buying a first property, for retirement or any other purpose.
“Alternatively, if you wanted to save for a first property you could invest the money and then drip-feed the £50,000 into a Lifetime ISA account. You can pay in up to £4,000 a year, but the money gets a 25% boost from a government bonus. It would take you just over 17 years to put the whole £50,000 into a Lifetime Isa, but at the end of that period it would be worth just over £145,000, assuming returns of 5% a year. That’s a significant house deposit for anyone getting on the property ladder.”
What about older student loans?
“Those going into their third year, as well as graduates that have finished university but have an outstanding loan, will be subject to the old student loan system.
“For most this will mean they’re also paying an effective 9% tax on earnings. But repayments begin at a different threshold, currently set at £27,295 on Plan 2 loans for those who started their course between 2012 and 2022. Plan 2 loans also charge interest at RPI+3% so the rate of interest is considerable, although the loan is written off after 30 years. The higher interest rate means there’s an added incentive to clear the loan quickly, although on the other hand the shorter term means the debt is less of a burden on those who never repay the full amount.
“Those on Plan 2 loans also need to consider whether future pay rises mean it’s worth paying off the loan sooner. Those who have been in work longer probably have a clearer idea of where their career may take them, giving them a better grasp on when they might wipe the debt through salary deductions. That information makes it easier to weigh up the pros and cons of paying off a student loan early.
“If you started university in 2011 or earlier then you’re likely to be on the Plan 1 loan. Most people will have a smaller balance thanks to cheaper tuition fees and lower rates of interest linked to the Bank of England base rate. If you still have a plan 1 balance outstanding then it’s worth exploring your options. Although the rate of interest is less punishing and you may already be close to clearing the debt anyway through your payslip deductions.
“It’s worth ensuring that you keep up to date with the Student Loans Company and make sure they have the right address for you. Once your loan is close to being repaid they’ll write to you outlining your options. It’s important not to ignore this letter otherwise you could inadvertently overpay via deductions from your payslip.”
How much you could repay on a Plan 5 loan:
