Should you overpay your student loan?
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Getting a student loan is the best way to pay for university, and it's well worth the cost in order to enhance your future earnings. But is it worth your while to pay that debt off early?
The changes to UK tuition fees at the start of the 2012/13 academic year means that many students will graduate from university with large student loan debts. Once you enter the world of work, you might be considering whether you should overpay these loans to get rid of them.
But is it worth it? Let's take a look.
The tuition fee changes
Universities are now allowed to charge up to £9,000 a year in tuition fees. Most are charging the full amount or close to it.
However, Scottish students studying at Scottish universities don't pay any fees and Northern Irish students studying at Northern Irish universities pay a maximum of £3,575 a year.
Students from England and Northern Irish students studying outside Northern Ireland are entitled to a £9,000 a year student loan to cover tuition fees. There are extra student loans to pay for living costs, such as accommodation, which vary depending on where you go to study.
Scottish students studying outside Scotland can apply for a tuition fee loan up to the full amount of their tuition fees. There are also living cost loans and grants, which are based on your family's income. There's more information on the SAAS website.
Welsh students can apply for tuition fee loans (up to a maximum of £3,465 a year) and living cost loans (up to a maximum of £4,745 a year, depending on where you study). The Welsh Government then makes up the difference with grants, depending on where you study.
Part-time students can also pay for their course with student loans, but they can't get additional student loans for living costs.
The earnings threshold above which English and Welsh university leavers start repaying their loans has now moved from £15,795 a year to £21,000 a year. This is due to rise with average earnings from 2017.
For every £1,000 you earn above £21,000, you'll repay £90 a year (£7.50 per month). If you quit your job or start earning less, your repayments stop.
Students are now being asked to pay above-inflation interest rates while studying and potentially afterwards, too. As before, interest piles up even while you're studying, out of a job, or earning under the earnings threshold.
Finally, the point at which outstanding student loans are written off for English and Welsh graduates has increased from 25 to 30 years, although the Welsh Government may pay off some of its graduates' loans. The period for Northern Irish graduates remains at 25 years, while Scottish graduates have their loans written off after 35 years.
Meanwhile, Scottish and Northern Irish students will repay £90 a year (£7.50 a month) for every £1,000 they earn above £15,795 per year. This threshold is being increased to £16,365 from 1st April.
How the changes affect students
For those paying the full £9,000 tuition fees via loans, monthly repayments will be lower, due to the higher earnings threshold, but students will take on a lot more debt.
The Institute For Fiscal Studies believes that while poorer students will be far better off during their studies thanks to increased financial support from maintenance grants, university leavers as a whole will be £9,000 worse off in their lifetimes than they would have been if they studied before the reforms.
However, despite the large debts and the higher overall cost, graduates can still, on average, expect to be far better off than people who didn't go to university, due to their higher lifetime earnings.
The taxpayer, by the way, will pay £2,000 less per student than previously, for the most part because subsidies are down and loans up.
The debt you'll never repay
If you were part of the previous tuition fees and student loan system or you're Scottish or Northern Irish, you can probably expect to repay your debt if you go into work. Despite the debt being wiped off in just 25 years, you have paid far lower tuition fees and your repayments have to start when your salary is more than £16,000.
If you have just started in the new £9,000 system from September 2012, you could have £35,000 to £45,000 in student debt by the time you graduate, especially since interest accrues even while you're studying and whenever you're not making repayments.
This shouldn't frighten you though. Looking at what an average student might earn in the 30 years following university, you might not be asked to repay your entire student loan and you'll only do so if your graduate earnings are high enough to justify it. Indeed, you may never pay off enough to notice the interest you've been charged, which will get wiped too.
David Willetts, Universities Minister, said: “We estimate that around half of all borrowers will have some part of their loan written off, as payments are contingent on their future income.”
That's half of you!
Low-earning graduates will get away with repaying only a small part of the debt over the three decades. It wall fall on the taxpayer to cover unpaid student loan debts.
Should you overpay?
University leavers in the previous scheme are likely to pay their debts in full and at very low cost. The interest rate matches inflation so, in real terms, the cost of borrowing is zero. Unless you have nothing better to do with your money, it will rarely make sense to overpay.
For many university leavers under the new system, you won't notice the difference in cost whether your course costs the full £9,000 per year, or whether it's thousands cheaper. If you pay £9,000, more debt will be wiped clean in 30 years, but you won't pay more during those three decades than someone on lower tuition fees.
That's why there's no reason for many students to pay off the debt early: doing so probably means you'll pay more than if you leave it 30 years until some of the debt is cancelled.
There are no risks to leaving the debt sitting around for your heirs; if you die inside those 30 years, those debts won't count against your estate.
Since much of the written-off part is effectively free money that you've already spent and will never repay, it would also be crazy to choose to pay tuition fees up front without using student loans.
It would be even crazier to pay existing student loans off by borrowing on a credit card or bank loan, since you'll then definitely have to pay the whole lot off, and probably at a higher cost.
High earners will repay their debts, plus interest
If you're a university leaver under the new system and you become a high earner, you are probably going to pay back more than you borrowed – unless this happens nearer the end of the 30 years.
This means paying it off early could be to your advantage, as it will decrease the interest you pay, and therefore the overall cost.
You're now thinking “What is a high earner?” It's impossible to say, because it'll depend on the size of the loans you've received, how long you've been studying, inflation, how quickly your salary rises compared to average salaries, and the total amount of time you spend out of work over the years.
Doing some sums, as a very, very rough rule, I would expect that you'll need to be earning around £30,000, at the least, within five or so years of graduating, or, failing that, your salary in later years will have to be vastly higher than average.
You probably have better options
Personally, if I was under the new system, I would only consider paying the debt off early if I was on such a high salary that I was clearly not a borderline case. I'm talking earning tens of thousands more than the median national wage per year – or much more than that if those high earnings start late in your career. Median national wage is currently in the low £20,000s.
That said, most higher earners will still have better options.
Your mortgage or other debts might easily come at a higher interest rate, so you're better off overpaying those first.
You could well be better off using spare income to buy a bigger house as an investment, or investing in more training to further your career and increase your salary even more.
Also, depending on the savings interest rates available to you, you could probably just about break even or perhaps come out better by saving, rather than overpaying your student loan. Doing this, you have the advantage that those savings remain available to you to spend or invest, if necessary.