Higher education fees and student debt have both risen in the UK. Since most of us are taught that debt in general is bad, shouldn’t you pass off student debts early if you can?
In this article, we’re going to look carefully at that question, and suggest you should not.
This is largely because student debt in the UK is very different from other forms of debt, such as credit card loans…
Student Loans: A Quick Overview
Student loans are provided by the Student Loans Company, and £1,000 tuition fees were first introduced in the 1998/9 academic year.
Maximum annual tuition fees were then increased to £3000 in 2004, and then to £9000 in 2012. Today, this £9000 cap rises with inflation.
This effectively created two repayment plans in the United Kingdom. Plan 1 affects those who started their university course before 1 September 2012, and Plan 2 concerns those who started their degree from this date.
Under Plan 1, you pay back your student loan once you start earning over £18,330 per year (this changes each financial year). You pay back 9% on income over this amount, and the interest rate is set at 1.5%.
Under Plan 2, you start repayments once you earn over £25,000 per year. While you study, you incur interest at the rate of inflation, plus 3%.
Once you start working, you pay back 9% each year on income over £25,000. The interest rate will vary, depending on your income in the previous tax year. If you earn over £45,000, for instance, then it will be inflation plus 3%.
Busting Some Myths About Student Loans
This can all sound quite alarming to potential students. After all, a 3 year university course is likely to incur £27,000 in debt just for the fees – leaving aside the maintenance costs.
But you need to remember that the price tag is actually irrelevant. Your student loans are automatically paid for by the Student Loans Company once your application is processed.
What matters is how much you practically have to repay, and this is determined by how much you earn from the first April after completing your studies.
If you earn a lot, then you will repay a fair amount. If your earnings are low, then you will pay back very little. Here’s an example of how this works:
Suzie studied under Plan 2, and started her first job after university on £27,000. This means she will pay 9% of £2000 to the Student Loans Company, because £27,000 is £2000 above the threshold. So that’s £180 (£2000 x 0.09).
Jenny, however, also studied under Plan 2 but got her first job at £18,000 after university. She will pay back nothing towards her student loan, as her annual salary is below the threshold.
So, lower earners really have nothing to worry about. Even many those earning over the £25,000 threshold are unlikely to pay it all back.
Remember as well, whatever student debts you still owe 30 years from your graduation are wiped out. So this really is very different from a bank loan.
There are also no debt collectors, as the repayments are collected from your wage each month by your employer. Your student loan also does not affect your credit rating.
So, Should I Repay It Early?
The UK government will allow you to repay your student loan early if you want to. However, for most people we think this would be a bad idea.
As mentioned above, your outstanding student debts are wiped out after 30 years. So what is the real point of working hard to repay a debt that is never fully collected?
Moreover, for most people paying it off early would actually lose either you or your parents money – possibly by tens of thousands of pounds.
Let’s consider an example. Suppose Jon wants to study third world development at university. His parents do not want him to be in debt, so they pay his £27,000 tuition fees up front. They also give him £21,00 to cover his living costs.
Jon later graduates successfully and works in the developing world for 15 years for different charitable causes. He never earns over £25,000 during this time.
When he comes back, he settles down and gets married. He becomes the full time parent of 4 children while his spouse works as the breadwinner.
By the time his children have grown up and left home, Jon has reached 30 years since his graduation. His student debt – which is still most of the £46,000 his parents originally shelled out – is now wiped out completely.
His parents could have done a lot more for Jon, rather than pay for university up front. Perhaps they could have put the £46,000 into an investment portfolio. Later, once the portfolio had grown, this could have been given to Jon as a deposit for a mortgage on a house…