Students

Navigating your student loan repayment

Nikos Melachrinos
August 19, 2020
Share

Illustration by Julie Campbell

Introduction

Every year about 1.3 millions students in England take out loans with an average loan amount of £36,000. Despite holding £121 billion in outstanding student loans, the Government expects that only about 30% of current full-time undergraduates who take out loans will repay them in full. And that’s due to the way interest and repayment works for these loans based on how much you earn. It’s not a typical loan, in that way. You only repay 9% of your earnings that are over £26,575. If for example you earn a salary of £31,575, which is £5,000 more than the threshold, you repay 9% of it – that’s £450 a year.


For a typical loan of £36,000 merely the interest (which can reach up to 6.1%) is more than £450 per year. What this means is that you will never get to repay your loan. Bleak, I know. The good news here is that this loan gets written off after 30 years (or when you die -  whatever comes first). In effect, after 30 years, assuming you never got a raise you would end up paying back only 30*£450 = £13,500 of the loan. After that it's written off, so you're getting a good deal.

From 2012 and after

It’s important to distinguish that how student loans work changed significantly in 2012 when tuition fees skyrocketed. Everyone taking a loan after 2012 fall under the “Plan 2” type. Plan 1 loans are very low-cost and it is well accepted that you shouldn’t be repaying more than you need to. In this post, I’m only covering “Plan 2” loans for more recent graduates that are significantly more expensive and it's worth considering how and when to repay them.


So the rule of thumb is that you shouldn’t pay your loan back early unless you’re earning over £40,000 per year and are enjoying regular raises in line with inflation (~3% annually).


Some key points about these student loans:

  • They don’t affect your credit score
  • They don’t affect your ability to take other loans
  • They don't work like other loans in that your interest rate and monthly repayment depends on how much you earn

Should you pay your loan early?

The answer is "it depends". It depends on:

  1. First off, how much is your loan. If you don’t take a loan for the full tuition cost plus cost of living then pull out your calculator and do some maths. For example, a £15,000 loan you might be able to reach the full repayment of the loan before the 30 year write-off. In that case, it's an expensive loan, and you should be repaying it early. If you're getting a loan for £40,000 then you would need to earn a lot more money in order to pay it off in less than 30 years. Which brings us to the next point:
  2. How much are you making. The more you make, the higher the interest rate on your student loan.
  • If you earn under £26,575 then you’re paying 2.6%
  • If you earn between £26,575 and £47,835 then you’re paying 4.1%
  • If you earn over £47,835 then you’re paying 5.6%

What it comes down to is the combination of these two factors. How much is your loan amount and how much are your expected earnings. Because even if you start with a smaller salary, but expect to get to a much higher salary in the future then you need to factor that in. What you need to figure out is based on your earnings, how many years would it take to pay off your loan. If the answer is more than 30 years ,worry not. If it's less than 30 years then you should pay off the loan as soon as possible. Granted you're not paying this loan before any other ones you have with a higher interest rate.

Adding on, the rule of thumb becomes if your loan is under £15,000 or if you earn over £40,000 straight out of uni then repay your loan early. 


How do you repay early?

If you've calculated that you should repay early, then the first thing to consider is to refinance the loan for a lower interest rate. Having a good credit score at this point in time would be nice. So, for your student loan you're likely to be paying the middle range of 4.1% for an undergraduate loan or 5.5% if you've taken a postgraduate loan. The cheaper end of personal loans is at 2.8% right now. So essentially you would take out a personal loan at the full value of your student loan, use the funds to repay it entirely and then start paying back the new loan. You should ideally do this only once you have to start repaying your student loan which is the April after you have graduated. You can thus benefit from a "repayment holiday".

Otherwise, stay on with your Student Finance but increase your payments above the 9% that's contingent on your salary.

All in all, student loans are a very controversial topic in the UK and the government is not transparent with the cost and the repayment of these loans. So it's necessary to look under the hood so you're not stuck overpaying for a loan.


Enjoy content like this? Subscribe to our weekly newsletter
Thank you for joining!
Oops! That doesn't look right.