Wednesday, 4 January 2012

Student Loans: Why You Shouldn't Pay It Back Early!

IMPORTANT: This information applies to people who began studying for their degree between 1998 and 2011. Pre-1998 loans are far more expensive and are much more worthwhile paying off sooner! 2012 and onward loans are different again, so please see this page for information on that!

On my sidebar, you can see that I am close to repaying the overdraft and other debts I accumulated whilst living as a student. You may be surprised to learn that figure does NOT cover the thousands of pounds I have in student loan debts.

Why do I not count this as soul-destroying debt that I should be digging myself out from underneath right now? The answer is that it is not consumer debt.

Whilst normal loans have an interest rate of 8-12%, a student loan's interest rate is set at either the Bank of England's base rate plus 1%, or the rate of inflation, whichever is lower. The current interest rate is 1.5%. Student loans do not affect your credit score either. This means that the value of the loan will stay the same in line with the annual increase in living costs.

Required Repayments
If you began your course between 1998 and 2011, you are required to repay 9% of your income over £15000. This begins on the 6th April after you graduate. If your wage falls below £15000 a year you stop making payments. The debt is wiped out after 25 years or if you die.

If you are an employee, the payments are be automatically deducted from your wages and will show up on your pay slip. If you are self-employed, you have to do some self-assessment calculations based on your income and National Insurance payments. Please see the government's website for more information.

Why NOT to repay your loan early
If you wish, you can make voluntary repayments on your loan. To the uninformed, this sounds like a wise use of excess cash, but there are two major reasons NOT to pay them off early!

The vast majority of debts, such as bank loans, car repayments, credit cards, mortgages, etc., will charge you much higher rates of interest than your student loan. Focus your efforts on repaying these (if you have them) to save yourself a lot of money in the long run. If you are planning on getting a mortgage in the future, any extra money would be best used to lay down a deposit on a house – the bigger your deposit, the less interest you will have to pay in the long run!

You can gain a lot more interest in savings than the interest paid on your loan. A cash ISA will give you in the region of a 3% return per year. Other savings could give you an even greater return if you decided to invest it.

Other types of student loan
Graduates who began their course before 1998 will have a different loan with a much higher interest rate. The advice above does not apply and I encourage you to research the best approach for your situation.

Students beginning their course from September 2012 will be subject to a different system again. The new, obscenely high tuition fees mean that most will graduate with over £50,000 in student debts, but you will not repay until you are earning above £21,000. See the Government's information page for more advice.


Isa said...

I paid for my course working while studying... that's why it took me 8 years, lol!

I am thinking on starting to sell my stuff, but the trays no, because there are no more in the charity shop :(


Michelle P said...

Wow I wish they had this here in the US!