You may have received your student loan statement and had to sit down quickly. Or you may have some extra cash and be wondering what’s the best use for it. In either situation, you may have wondered whether to pay off your student loan a bit more quickly.
If this is you – and this may come as a surprise – clearing your student loan early may not be your wisest financial move. Let’s take a look at why.
What kind of loan do I have?
If you are considering paying off your UK student loan, check what type of loan you have:
- If you are an English or Welsh student who started an undergraduate course anywhere in the UK before 1 September 2012, or you are a Scottish or Northern Irish student who started your course on or after 1 September 1998, then you will be on Plan 1.
- If your course started after 1 September 2012 in England or Wales then you will be on Plan 2.
You start to repay your loan from 6 April in the year after you graduate.
There are key differences in what you are required to repay, depending upon which student loan you have:
Plan 1 – You’ll pay back 9% of everything you earn above £18,935 a year (increasing to £19,390 from 6 April 2020).
Plan 2 – You’ll pay back 9% of everything you earn above £25,725 a year.
So under Plan 1, if you have an annual salary of £30,000 you will repay a total of £995.85 in a year. Using the same salary example, under Plan 2 you will repay a total of £384.75 in a year.
If you are in employment, then your payments will be deducted from your taxable earnings. You will see your student loan repayments on your payslip. If you are self-employed, HMRC will calculate what you owe each year in repayments once you have filed your tax return.
If you earn above the relevant threshold above, then you will automatically make repayments towards your loan. However, if your income falls below the threshold, then your repayments will pause.
Should I repay my loan?
Here is the million dollar question – or the thousands of pounds question if you prefer. If you can overpay or pay off your student loan, should you?
Basically, unless you are a higher earner (salary of over £50,000 per year) who is free of debt and will not want a mortgage or a loan in the future, the answer if probably no. And here’s why.
The interest on your student loan is kept in line with inflation. If you are on Plan 1, your interest rate will be the Bank of England base rate (currently 0.75%) plus 1%, or just the rate of inflation – whichever is lowest. Therefore, there is no real cost of borrowing, as what you are repaying is the rate of inflation.
To simplify it, imagine you have borrowed enough for 30 fill-ups at the petrol station. While the numbers on your statement may have increased due to interest, because they have only increased in line with inflation the reality is that you have still only borrowed enough for 30 fill-ups at the petrol station even if it’s 10 years down the line.
It is slightly different if you are on Plan 2. Your interest rate will be the UK Retail Price Index plus 3% while you are studying. Once you have graduated, your rate will range from just the Retail Price Index to the Retail Price Index plus 3%, depending on how much you earn. Although higher than the interest on Plan 1, the rate is still lower than what you would find at any high street bank.
And the key thing to remember with a student loan is that eventually it will be cleared. If you graduated before 2005/2006 your loan will be cleared when you are 65, if you graduated after 2006 it will be cleared 25 years from the first April after graduation, and if you graduated after 2012 it is 30 years from the first April after graduation.
Where should my money go instead?
As your loan will be cleared eventually, there is little point overpaying it if there is a likelihood that you may not pay it off in full anyway (if you earn above the threshold you will automatically make repayments). You could end up devoting money towards paying off a debt when you don’t need to. Instead, there are other things you can use your money towards.
Firstly, try to pay other outstanding debts. Any loans or credit cards that you have are likely to be a more expensive form of borrowing than your student loan, so try to clear these first.
Secondly, saving is always a great thing to do if you find yourself with a little extra money. Either you can save for something specific like a house deposit, or just save for the future in case your circumstances change. Either way, if you manage to find a savings account that pays a decent rate of interest, you are likely to gain more from that than from paying off your student loan.