Gosh, student loans are becoming a trickier and trickier subject as the years go on. On one side you have people telling you to get out of student debt as soon as possible, and on the other you have people telling you you shouldn’t worry about student loans and use the money for something else. Which is right? Well well, let me put down the facts and let you make up your own mind.
Here’s what we’ll be talking about today:
- What are student loans and why do we use them?
- How the repayment process works in the UK
- Should I pay them off?
What is student loan debt?
Student loan debt is the strangest and most different form of debt you’ll ever come across. In fact, many people disagree that it should even be called debt in the first place. I’ll explain in more detail below.
Student loans are effectively a way for students to pay for university if they or their parents can’t afford to do so. The Government kindly (or not) lends you some money and with that you get to cover university fees as well as living costs. In some countries (yay Scotland) you might not have to pay for university at all and only need a loan for living costs.
We can consider student loans good debt: you’re taking out money to educate yourself and to help you find job opportunities once you graduate.
So you’ve applied for your student loan and now receive a certain amount from the government to help with costs. When you graduate you will owe the government three things:
Tuition loan: How much you took out to cover college expenses
Maintenance loan: How much you took out to cover living expenses
Interest: The percentage added on for borrowing money in the first place
And although you may look at numbers and think ‘oh my, I’m graduating £40,000 in debt’, after reading this article you’ll realise that it actually doesn’t matter how much you owe, what matters is how much you’ll repay.
How the repayment process works
The student loan repayment process is an interesting one. First of all, you only start repaying anything until you earn more than £21,000 a year (soon to be increased to £25,000 in April 2018). Once you start earning that, only a certain percentage of your income (9%) goes to the Student Loan Company. As your income increases, so does the amount you pay back. Here’s a lil’ table from the Gov site to make things clearer:
The calculations: 25,000 – 21,000 = 4,000. 9% of 4,000 is 360. So as the table demonstrates, you’d pay £360 per year, or £30 per month.
If suddenly you stop earning money, your repayments stop. They also stop after 30 years. If you’re self-employed you’ll still be repaying your student loans through a Self-Assessment.
So as you see… it’s all about how much you’re going to repay. If you graduate with £40,000 of loans but earn under £21,000 for 30 years, you won’t ever repay anything. If you earn £25,000 for 30 years you’ll only repay £10,800 of those £40,000. See where I’m getting at?
This is why people who understand student loans don’t really consider them debt: there’s a high chance you won’t pay them all off (in fact, 83% of students don’t), and you only pay it when you’re earning an income. It could even be called a contribution. The system was designed so that people contribute to their education in proportion to their financial success: if your degree got you a higher paying job, the more you have to contribute back to the funding of that degree.
And you may have already figured out that what you pay back does not depend on how much you owe, it depends on how much you earn. Student A graduates with £50,000 in loans and student A graduates with £10,000, but they both get a job earning £25,000. They’ll both be paying back 9% of £4,000, so £360 every year – just one will pay them off sooner. It really is all about the salary.
Let’s look at some more detailed examples of students graduating university and paying back their student loans.
1. Damian graduates university with £52,166 in student loans. He gets a job earning him £27,000 a year. £27,000 is £6,000 above the £21,000 threshold, so he will contribute back 9% of £6,000 = £540 in the first year. If his salary doesn’t change at all (unlikely), he’ll only have paid back the equivalent of £16,200 after the 30 years are over. For a more accurate answer (taking into account salary increase), check out these calculators: University Guide, Save the Student, Money Saving Expert
2. Emma also graduates with £52,166 of student loans. She gets a job in banking and earns £60,000 in her first year. After doing some calculations and research, she realises that it will take her 20 years to pay off the entire student loan, and by then the total will be £76,940. She decides that she could afford to pay them off early and does so to avoid paying the extra £24,774 of added interest.
So as you can see, these two cases are pretty different: one will never pay off her entire student loans, and the other decides to pay them off early simple because he can and he wants to avoid additional interest.
Should I overpay?
I only used two examples in the last section, but it’s obvious that the situation can vary hugely from person to person. You may take a career break and travel the world for 2 years, you’ll probably change jobs several times, you may decide to live off property investments and not have a job at all (and yes you’ll still be paying back the loan). Every case is different, which is why it’s so important to understand student loans so that you know what to do in your particular situation.
Many times overpaying your student loans could be a bad decision: you might be better off putting your money into a Savings/ISA account and paying off other, more expensive debt (credit cards!!!) than tackling your student loans.
An easy way to decide whether you should overpay your loan: will overpaying significantly reduce the amount you pay over the 30 years? In Damian’s case, it reduced it by £24,774. He thought it was worth it and decided to overpay. If the amount is significant for you, then go ahead, but if it has not much impact, you’re better putting your money into something more productive.
Also remember that you may have way more important debts in the future: car, mortgage, business, etc. Think of your student debt as an extension of your tax; a contribution of your income in return for the degree that (hopefully) was useful.
It’s hard to understand what student loans are all about when you hear stories of Americans paying off $60,000 of student loans in 2 years and everyone works hard to be ‘debt-free’. In the UK, you don’t need to worry about student loans unless you believe paying them off early will save you money. What you DO need to be more cautious about is credit card debt, mortgages, car loans, etc. The interest rates are higher and the companies are not so generous: if you stop earning an income, you still gotta pay ‘em back.
So next time you hear someone gasping at a ‘I’m graduating with £40,000 in student loans’, take a deep breath and show them this article. Spread the financial education.
Some cool resources
Oh and by the way, I have a sweet FREE 6 day course to help you get your head round student loans, debt and savings. Check it out: