Your student loan is not debt
And Why You Really Need To Understand It
‘Millennials’, ‘generation Y’, ‘generation debt’, call us what you will. When it comes to the D word, there is no debt more synonymous with our generation than our student debt. Debt can be daunting and downright scary at times, but you should know that not all debt is created equal, and most importantly, not all debt requires the same approach when it comes to being repaid.
What am I talking about? In this post I’m going to focus on UK student loans. The kind that any recent graduate or current student has the pleasure of knowing all too well. Specifically, I’ll be referring to Plan 2 loans that came into force post 2012, in response to the £9,000 per year fee increase. If you have a Plan 1 loan (pre 2012) then it’s best to do your own research of the specifics, yet some of the most basic underlying ideas still apply.
To say that the issue of student loans is politically charged would be a huge understatement. For the sake of this post though I want to keep things strictly practical; if you find yourself in £50,000 (and rising) of student debt and frankly don’t feel too great about that fact then you should read on. The ‘debt’ label is misleading when applied to student debt as these loans don’t behave like any other loan (mortgage, personal loan etc). And so, unsurprisingly, the advice on how to treat them is pretty unique too.
Quick facts about Plan 2 student loans:
- How much debt are students in? Roughly £50,000 at graduation (£44,000 from tuition and maintenance loans, plus the first chunk of interest)
- What is the interest rate for the loan? In short, it varies, but the top rate is currently 6.3%
- How is the loan repaid? Graduates pay a flat rate of 9% of all their income earned above £25,000, this is why student loans are often referred to as a ‘graduate tax’. *the £25,000 income threshold will increase each year with inflation and is due to rise to £25,725 from April 2019
- How long will the loan last? A maximum of 30 years from when you graduate, at which time the debt is wiped regardless of the balance
- How many student are expected to pay off their debt in full? Only 17% of the student population, according to the IFS
The mechanics of the student loan — what you need to know:
- The rate of interest varies on what you earn — the current 6.3% (3% + RPI inflation) rate is headline grabbing, but in truth it is variable. This top rate only applies to people earning over £45,000, which means a very small group of graduates. For those under £25,000 their interest is pegged to inflation.
- The interest rate changes every September, and is based on inflation at the time — the interest rate on loans is reviewed on 1st September each year and depends on the RPI measure of inflation. The current rate (3.3%) is the highest it has been for 5 years, although it’s hard to predict whether the rate will rise or fall in future.
- The amount you owe doesn’t impact the amount that you repay (it’s your income that matters) — seeing interest pile up on top of the loan is intimidating, but the total debt amount actually has no impact on your monthly payment. On the other hand income has a real impact, particularly as your income starts to climb. For example anyone earning £35,000 per years repays double (£900) that of someone on £30,000.
The BIG question — what about repayment?
With reported interest rates of 6.3%, anyone with an understanding of how conventional debt works should be in a huge rush to start repaying, but remember student loans behave differently. For most people it would be a mistake to start repaying too quickly. So, should you try to pay off your loan early? First consider these questions:
- Is your starting salary £40,000 or more?
- Do you love your job and imagine yourself doing it in the long run?
- Is there a transparent and increasing salary structure in your industry? (think banking / consulting / law)
If you are able to answer yes to all of those questions then you are very likely to be able to pay off your loan over the next 30 years (use this calculator for a more in depth estimate). If you are confident in being a future high earner then you could benefit from starting to pay down your student debt more quickly to keep interest to a minimum. This is because the interest rate of your loan is much higher than that of other financial products like mortgages and savings accounts. Note if you have any shorter term or personal loans then prioritise paying off these as they have the highest interest rates of all.
If you (like 99% of others) are completely normal in not being so sure of what you might want to end up doing, or what you’ll get paid in return, then the short answer to student loan repayment is don’t rush. I’m not saying ignore it and it’ll go away, but I am saying don’t lose any sleep over it. This is because careers take time to build, progress doesn’t take a straight line and the next 30 years will be defined by jobs that don’t even exist yet. The most important thing is to understand how your loan is made up so that you know how the rules will impact you as your income gradually starts to grow.
So we know that 83% of graduates aren’t expected to pay off their loans in full (a weirdly specific number for such a long term forecast). We know that repayment is a game of two halves, where the top earners should get it paid quickly (aiming for 15 years) and the lower earners shouldn’t worry as their debts are likely to be wiped before being paid. This is the crux of the problem, and if — like most people — you fit into a grey space somewhere in the middle then my advice is this:
- Don’t rush to make early payments as this could mean money wasted
- Understand exactly how your loan works
- Keep up to date with any changes to terms/interest rates
- Understand how any career changes will impact your future loan repayments
‘Money: A User’s Guide’ by Laura Whateley (check out Chapter 3 — ‘The Debt You Are In and How To Handle It’)
Important disclaimer — I am not a financial advisor and I will not be telling you what to do with your money. Strange I know, but I find personal finance pretty fascinating and am happy to read up and write about the thoughts of genuine money experts so you don’t have to.
Talk to me — I’m always keen to hear any thoughts you have and to receive suggestions on topics of particular interest, just get in touch.