Student debt: Pay it off?
If you're in your 20s and have student loan debt, should you pay it off early? Donna Werbner doesn't think so.
Baked beans. Late-night kebabs. And lots and lots and lots of rounds at the student bar. That's what I spent most of my student loan on. "I've earned it," I'd joke to my parents. "Well, I will have done, in the future...."
Guess what? Now, the laugh's on me. Every month, a great big dollop of my salary is transferred automatically to the Student Loans Company. I've been paying for those kebabs and rounds of booze for five-and-a-half years now, and I estimate I'll need at least another two-and-a-half years of payments at my current level before I'm free and clear.
But should I try and pay it off early? At the moment, I'm managing to save a little every month and contribute a small sum to my pension. Would I be better off using this money to get rid of my student debt, instead?
The savings question
The good news is, the interest rate paid on student loans has fallen dramatically from 4.8% in August last year to its current level of just 2.5%.
The bad news is, savings rates have fallen dramatically too.
Here's how much you need to earn on a savings account, before tax, to beat the amount you're paying out in interest on your debt:
|Taxpayer||AER (Gross) On Savings|
A quick search on our whole-of-market savings search engine shows me that the highest rate you can get on an instant access account is 3.6% from Tesco.
So basic rate taxpayers who took out this account would be better off saving rather than paying off their student loan, while higher rate taxpayers would be worse off.
But this only applies if you haven't used up your ISA allowance this year. You can save tax-free in an ISA, and Natwest is paying 3.25% on its e-ISA. So both basic-rate and higher-rate taxpayers who took out this account would beat the student loan interest rate by 0.75%.
Also, I think this approach of looking at savings rates vs the student loan rate is too simplistic. There are other important factors to consider.
More good news
The student loan rate is set in a very complex way. It is either the same rate as the Retail Price Index (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 just 0.9%. If it remains below 2.5% until March, you will see a reduction in the student loan rate in September this year, which will then apply until September 2010. The same goes if there are further base rate cuts over the next six months, which are then reflected in the base rates of the major banks.
In other words, there's a good chance the student loan rate will fall even further this year, and remain low over the next 18 months, meaning less interest to pay.
Shouldn't you pay off debt ASAP?
You may be sitting there reading this and thinking: that's all very well, but I thought it was always better to get rid of debt as soon as possible? I don't want lots of debt hanging over me for a decade or more.
Normally, you'd be right to take this approach. But 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.
Other financial priorities
If you have other financial priorities, I think you will be better off putting your money towards those instead.
For example, it is now almost twice as 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. As David Kuo explains in this video podcast, now is the perfect time to start dripping money into the stock market for a pension, as shares are relatively cheap. And as our editor Ed Bowsher points out, it's also a very good idea to start contributing to a pension while you're young, due to the miracle of compound interest.
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.
If you do, I promise you, you'll regret it, one day....
More: Start Your Pension Early