Should you pay off your student loan more quickly?

Should you pay off your student loan more quickly?

When I was sixteen back in 2010, I didn't want to go to university. I didn't know what I wanted to study, fees were just about to triple to a whopping £9,000 per year and students were protesting in the streets. 

Graduation1.jpg

My A-level maths teacher talked me into it though. She convinced me that it was a great investment in my future. She said that despite the potential £45,000 debt that I might come out with, this loan was offered at a reasonable interest rate of 1.5% (£675 per year). This would've been a small price to pay for the huge boost my degree would give to my career prospects.

What I realised later on was that the new loans wouldn't have the same interest rates as loans taken out in 2010. Their interest rate would be controversially set at the RPI (Retail Prices Index) as a measure of inflation.

And once you earn above £25,000 that rate goes up, all the way to an additional 3% if you earn £45,000 or more.

This means that the interest could easily be double (maybe even quadruple) what the old rate was. It's complicated to work out how much you'll end up paying back and I'd suggest pumping in some rough numbers into this website.

Although it doesn't take into account that RPI can vary massively over time, it's a good start to estimating the costs.

For example, if you were earning an average graduate salary (£25,000) after you graduate with a debt of £44,000 and got a 1.6% pay rise per year, you'd never pay off the loan and you'd have paid an average of £1,940 a year for thirty years. This is illustrated below.

Liam Hartley's student loan illustration

Should I just pay the minimum?

So when is best to try to pay back your loan? Unlike most loans, you don't owe Student Finance England anything until you start earning above £25,000. 

Eighteen year olds going to university now are very likely to live for another sixty years after studying and, for many, their student debts will have been written off long before that (after thirty years). The debt is more like a "student tax" which takes a small portion of your salary. 

For many graduates on average salaries, it will make sense to pay only the statutory minimum as required by the Student Loans Company. That will go for even better off graduates too, as they are likely to have a range of other financial commitments and expenses.

However, if you're earning more than the average graduate - maybe you've already had a few pay rises - there is an argument for defending yourself against the loan's interest creeping up on you by paying it off more quickly.

Let's imagine that the Bank of England have just announced that they plan to pump out tonnes of newly-printed money and drop it all over England. Inflation is almost guaranteed to rise and the interest on your student debt is about to go through the roof. You could pay off some of your loan immediately when this happens to avoid the crippling compound interest. Or, ensure that your portfolio has the appropriate measures to deal with inflation. 

An "inflation-linked bond" is one way to do this as your savings will make more money as inflation rises. So whilst inflation may cause your student debt to increase, it'll be balanced out with an ILB. 

So, is university worth the associated costs? 

The price of university is a lot more complicated than £9,250 a year. I urge you to thoroughly consider the costs and to understand how to defend yourself against inflation in the future if you can. But the rewards are also a lot more complicated than an increase in your job prospects. Moving to London for three years to study and spending one year in Miami was a priceless experience. It completely changed the way that I see the world and how I see myself. It introduced me to some of my best friends and gave me the opportunity to pursue my studies. 

It's a hefty investment in yourself, but some of the benefits are priceless. 

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