Q&A: Should I repay my student loan early?
After years of spending on beer, boozy nights out and (occasionally) text books, many students wake up to find they have the worst kind of hangover: a financial one.
Nowadays, going to university isn’t as simple as getting a grant, writing a few essays and living life large at the taxpayer’s expense. Getting a degree is a costly business.
Push, an independent organisation that offers advice to students, says student debt now tops £4,500 for each year of study – and the average projected debt on graduation is in excess of £14,000.
1. So, should I worry about what I owe from my student days?
That depends on the types of debt you have.
If you owe money on credit cards, an overdraft or a loan from a bank, you should make paying these off a priority. That’s because it’s likely you’ll be charged high rates of interest on these forms of debt, and the longer it takes you to repay them the more expensive they will be.
However, your official student loan (from the Student Loans Company) is probably the cheapest form of debt you’ll ever have.
Therefore, deciding whether or not to pay it off early isn’t straightforward.
2. How much interest is charged on student loans?
In theory, graduates should only have to repay the same amount they originally borrowed in real terms. Ordinarily, therefore, the rate of interest charged on student loans is equal to inflation (the rate at which prices rise).
This is supposed to ensure that student loan repayments don’t diminish graduates’ real spending power. It works like this: if what you originally borrowed would have bought 100 baskets’ worth of goods, you should ultimately pay back a sum that would allow you to buy those same 100 baskets, taking price changes into account.
The measure of inflation used to set student loan interest rates is the Retail Prices Index (RPI). Usually, the interest rate charged on student loans is changed each September to match the RPI from the previous March.
However, the rules are different for loans taken out after 1998. They state that, if the highest base rate of a number of high street banks plus 1% is lower than the RPI, this should be the rate charged on outstanding student loans.
3. What’s the current cost of student loans?
The RPI for March 2009 was negative: -0.4%. On 13 May 2009, the government explained how this will affect student loan interest rates. Loans taken out before 1998 will attract a negative interest rate of -0.4% from Setepmber 2009 to August 2010. Effectively, this means graduates will be 'earning' money on their debts!
Graduates who took out loans after 1998 will be charged 0% interest on their ourstanding balances from this September, rather than a negative interest rate.
Although this is a departure from the rules originally set down for the administration of student loans, the Student Loans Company has said paying graduates interest on their oustanding loans would have been difficult to justify to taxpayers during a recession.
3. Will owing money to the Student Loans Company affect my credit rating?
Credit referencing agencies do not hold data on post-1998 student loans, so if you took out a loan after this date what you owe the Student Loans Company will not appear on your credit file.
Having said that, the payments that you make to the Student Loans Company through the PAYE (Pay As You Earn) system will affect your ability to afford other debt repayments.
If you apply for credit and are asked to outline your current debt commitments or give details of your disposable income, your student loan repayments may affect the outcome.
Those people who took out loans before 1998 are in a slightly different position, as their debt repayments are structured in a similar way to those on a personal loan from a bank.
This April, the Student Loans Company announced it will pursue people with pre-1998 loans who are in arrears or late with repayments. They may apply default notices to people who do not pay up, which would show up as a black mark on an individual's credit file.
4. What are the advantages of repaying my student loan early?
Many people believe they will feel better and freer for having repaid their student debts – and this is a key reason why they wish to do so as quickly as possible.
The key financial advantage of paying off your student loan quickly is the effect this will have on your monthly disposable income.
Once you are no longer losing a proportion of your pay to the Student Loans Company, you’ll feel better off financially.
5. What are the disadvantages of paying back my student loan early?
There are disadvantages to repaying your student loan at speed.
Firstly, it’s worth noting that the interest rate charged on student loans is usually lower than the best savings rates available.
This means you could end up financially better off by saving any spare money you have in a high interest account (preferably a cash ISA). This is because the amount you’d earn in interest should, in theory, outweigh that being charged on your outstanding debt.
Furthermore, it is important to be aware that by paying back your student loan instead of saving, you could increase the likelihood you’ll need to borrow money later – probably at far more expensive rates of interest than you’re currently being charged.
If you choose to buy a home, for example, you’ll need a larger mortgage if you have only managed to save up a small deposit.
In the current climate, this is certainly something to consider carefully. Mortgages are currently more expensive for home buyers with smaller deposits, and it can be impossible to get a mortgage without a deposit of at least 10% of the value of your property.
6. So, what’s the verdict? Should I repay my student loan early?
Ultimately, what you decide to do should depend on how much money you have to spare and how likely it is you’ll need to borrow in future – especially if paying your loan off early means you can’t start to save.
Personally, I won’t be rushing to repay my student loan for all of the reasons outlined above.
Also, remember that if you took out your student loan after 1998 you will not be required to make student repayments unless you are earning more than £15,000 per year – and if you stop earning, you will stop paying.
Graduates with loans dating from before 1998 are required to make regular loan repayments according to a set scheme, but may be able to defer repayments if they earn under a certain amount. If you’d like further information on student loan repayments, it’s worth visiting Studentloanrepayment.co.uk.
**This material is for information purposes only and should not be considered financial advice. We strongly encourage our readers not to rely solely on this content, but to seek independent advice when making financial decisions.**
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