Bad news for everyone in their 20s

by Donna Werbner on 20 April 2010  |  9 comments
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The huge jump in inflation today was a double-whammy of bad news for anyone in their 20s with student loan debt.

The huge jump in inflation today was a double-whammy of bad news for students and recent graduates.

Figures out today showed the Retail Prices Index (RPI) rose sharply from 3.7% in February to 4.4% in March.

So struggling students and recent graduates – many of  whom are likely to be unemployed following the recession – will have to face higher living costs. But on top of this, they could also face a massive jump in the cost of their student loans, something which will affect everyone currently in their 20s.

What will the rate be?

Student loans are supposed to charge interest at the rate of inflation – and this rate is always set as the March RPI figure.

In other words, the interest rate charged on student loans could rise dramatically from its current record low of 0% (following the fall in inflation last year) to as much as 4.4%.

But not for another six months. And even then, the good news is, it might not happen for certain, as long as interest rates remain low.

This is because the student loan rate is set in a very complex way. It is always set in September for the next 12 months, either at the same rate that the RPI was in March, or it is the highest base rate of a number of major banks plus 1% - whichever is lower.

The RPI is currently 4.4%. If the base rate of the Bank of England remains below 3.4% in September, then student loan borrowers are likely to pay less than 4.4%. For example, if the base rate stays at its current level of 0.5%, borrowers are likely to be charged around 1.5% in September.

The bad news is, if the base rate rises at any point between September 2010 and September 2011, then the student loan rate will also rise in line with this.

However, if the base rate jumps up to above 3.4% at any point, then student loan borrowers will still only pay 4.4%, maximum.

Confused? I'm sure you're not the only one... If you have a question about anything to do with student loans, why not head over to Q&A and ask over lovemoney.com readers what they think. I've tried to think of the most common questions and my answers to them below, but if you have anything more specific you want answered or if these don't cover it, the lovemoney.com community is waiting to help you.

What should I do?

If you have a student loan, the key point to bear in mind is that your rate is set at 0% for the next six months, regardless of what happens to the base rate.

After that, it’s very likely that your rate will go up.

So if you’re only a few months off paying off your student loan, you may wish to consider paying it off early, in September.

What if I can’t afford to pay it off?

Remember that the student loan is not your typical sort of debt.

Firstly, and most importantly, you do not have to worry about this debt being a burden to you if you stop earning. You need to earn over £15,000 a year before the Student Loans Company will take any money off you. Even then, the amount you have to pay will depend on how much you earn.

What's more, if you reach 65 without paying it off, your debt will be cancelled. The same goes for if you die.

What if I can afford it, but I’m not sure I should pay it off quickly?

Although today’s news is bad news for student loan borrowers, there’s no need to panic about paying off your student loan in the next six months – even if you can afford it. If you have other financial priorities, I think you will be better off putting your money towards those instead.

For example, it is still much more expensive to try to get a mortgage with a 10% deposit compared to a 25% deposit. You'd be looking at paying a rate of around 6%, compared to around 3.5% with the bigger deposit. On a £100,000 mortgage, that's a saving of more than £200 a month.

So if you're looking to buy a property at some point over the next year or two, any extra money you can put towards your deposit could really make a big difference. Even if you're not earning very much on that money in interest, you should be better off in the end.

Similarly, if you have any other sort of debt - such as credit cards or an overdraft - you are likely to be paying around 16% interest. So it's vital to pay this more expensive debt off before your student loan.

You may also want to consider putting the money towards your pension instead. If you start saving as little as £170 a month in your twenties, your pension could be worth almost a million pounds by the time you retire! Read Turn your pension into a million pounds for more information.

But whatever you decide to do with your spare cash, make sure you don't squander it on kebabs and booze and greasy fried chips from the Van Of Death, like I did when I was at uni.

If you do, I promise you, you'll regret it, one day....

More: Up your pension pot by £94000!