Should I Repay My Student Loan? 2022 Debt Rules
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This is definitely one of the most common questions asked by millions of former graduates in the UK. So, you have some extra cash and want to repay your student loan. First of all, congrats on actually having the money to pay off your loan! Secondly, before you go on and deposit that money to get rid of your student debt, I strongly urge you to step back and think things through for a second.
Do you have other debts?
When did you start college/uni?
Your answers to those two questions will make all the difference because they will determine whether your interest rate for this academic year is 1.25% or 3.1%. If you have started uni before 2012, below, you will find handy tips to easily and quickly be able to decide whether it is to your best interest to pay your student loan off now or not. This step-by-step-step guide will also help you find out how to work out your situation the best possible way.
STEP #1: What Is The Type of Your Student Loan?
From 1990 and onwards, a whole lot of young Brits got student loans. Back then, practically everyone starting higher education was eligible for a student loan. So, it comes as no surprise that there are graduates that still have them, even if they have finished uni some 25 years ago! This is because, unfortunately, only a handful of these millions of people were properly educated on financial matters back then. We will start by helping you find the type of your student loan and take it from there.
LOAN TYPE: Income-Contigent Loan
(1998-2011 for English & Welsh Students + post-1998 for Scottish & Northern Irish Students)
|Current Rate (since September 2017)||1.25%|
|You Repay||9% (for earnings over £17,775)|
|Impact on Credit Files||None|
|Defer Payment||No, but you only repay if your earnings are over £17,775.|
|Overpay||Yes (via bank transfer, cheque or card).|
The Student Loans Company (SLC) refers to them as Plan 1 Loans. If you started higher education between 1998 and 2011 (Northern Irish & Scottish students starting after 2012), chances are you have this type of loan. The interest rate for this academic year (2017-18) is 1.25% and is usually based on March’s inflation rate (RPI – Retail Prices Index) unless the UK base rate +1% is lower. The base rate +1% is at 1.25% while the inflation rate in March 2017 was 3.1%. If the base rates change, the rate can either drop or increase by mid-year.
Note that this loan’s interest rate is ALWAYS lower than either the rate of inflation or the Bank of England base rate, plus 1%. The rate of inflation is fixed every start of September based on the RPI measure from the previous March. However, we need to wait until August each year to have the actual rate officially confirmed.
For annual earnings over £17,775, you repay 9%. So, if, for example, you earn £19,000, you will repay £110 a year. If your earnings are below the threshold, a monthly repayment will only be deducted if you, somehow, earn over the monthly limit of £1,481 (i.e. have overtime or bonus earnings). In this case, wait until the end of the tax year. If your P60 shows total earnings below £17,775, you can claim the monthly repayment(s) back from the Student Loan Company.
Repayments are given to HMRC (HM Revenue & Customs), which, in turns, pays the Student Loan Company once a year (every March). Although it may not feel like you are paying only the interest absolutely necessary throughout the year (perhaps, this is because the Student Loan Company applies repayments as if they had received them every month), you actually do.
- EMPLOYEES – The money is taken from your payroll automatically. It is pretty much the same way taxes are withheld from your payroll. No debt collectors whatsoever. Beware that you must tell your employer if your salary is above £17,775 and the repayments are not being deducted. Your employer will face a £1,000 fine if they don’t deduct payment after you have asked them to.
- SELF-EMPLOYED – When you do your self-assessment form, you MUST notify HMRC of any payments. Consider part of your income any additional income you may have from dividends, shares or savings interest if the total income from them exceeds £2,000 (this kind of income is counted for repayment purposes). In this case, you WILL need to repay 9% through the self-assessment form.
- INDIVIDUALS THAT HAVE ALMOST REPAID THE LOAN – Call the SLC on 0300 100 0611 and let them know. Since they assess your balance each March, it is impossible for them to know whether you are almost done with repaying the loan. If you don’t notify them, they will continue to take payments, even after the time you have cleared the debt.
- DIRECT DEBIT PAYMENTS – This is an option for those that have almost paid off the loan. You may choose to leave the PAYE scheme and switch to making payments by direct debit every month until you clear the debt. Now, if you have already overpaid, you can certainly get your money back.
- You can use a bank transfer, cheque or card to overpay
- Although there are no changes due at the moment, if you are on a “post-1998” loan, you will see the amount you need to earn before you start paying (aka repayment threshold) rise with inflation annually. Remember that the inflation rate is based on the RPI inflation rate in the previous March. So, you will pay less back every year (if you don’t have pay rises occurring annually).
- Regarding the student loan sell-off initiative the Government has put into effect to sell off the remaining £40bn of student loan debt it has, it is believed that the terms of the loans will not be affected. However, this doesn’t rule out a change in older regulations.
LOAN TYPE: Mortgage-Type Loan
(1998-2011 for English & Walsh Students + post-1998 for Scottish & Northern Irish Students)
|Current Rate (since September 2017)||3.1%|
|Impact on Credit Files||Yes, if you miss a payment or are a late payer. The SLC will contact you. If you don’t reply within 28 days, late or missed repayments will go on your credit report.|
|Defer Payment||Yes (if below £29,219).|
|Overpay||Yes (via bank transfer, cheque or card) – Contact debt administrator first.|
If you started higher education anywhere between 1990 and 1997, you probably have this loan. Again, the interest rate is set exactly the way as with the previous type of loan, only, this time, it is determined by the inflation rate of the previous March (March 2017 inflation rate: 3.1%).
You must earn more than £29,219 every year to start making repayments. Of course, nobody will stop you if you want to pay before you reach that threshold. As for how you pay these loans, let’s note that you are responsible for repaying the loan to the private company it has been sold to, by cheque, card or direct debit. You can find more information about which companies now collect the loans at the SLC.
Finally, there are no changes due in the way you repay, despite the fact that private companies now owe the remaining £900 million student loans taken out between 1990-98 (sold by the Government), which means that you will need to make the repayments to them; not the Government.
STEP #2: What is So Different With Student Loans?
There are 3 fundamental reasons why student loans are an entirely different thing than any other form of borrowing:
1) Student Loans Have No “Real” Interest Cost
Student loans taken out before 1998 and between 1998 and 2012 have no “real” cost of borrowing because the maximum rate you will pay is the rate of inflation (the rate at which prices rise). This means that if inflation is, say, 5%, something that costs £100 this year will cost £105 next year. This has nothing to do with other forms of borrowing because if inflation is negative, the debt of these loans can actually shrink! Not to mention that with any form of commercial borrowing you borrow money, and then pay not only the amount you have borrowed back but also cash on top for fees and interest. Over the years, that extra money you give add up to hundreds if not thousands of pounds. Yes, inflation is not stable throughout the year. Your repayment rate is, though.
Note: This does NOT apply to student loans taken out from 2012 onwards.
2) You Repay Only If You Earn Enough
With normal borrowing, nobody cares whether you can afford to make repayments or not. It is a much different story with student loans, where you only repay if you earn enough money that allows you to repay the debt. This also applies to the cases when your income drops after you have already started paying. The student loan company will not come asking for the money if you, say, lose your job (unlike other lenders). Simply put, if you don’t have enough money, you don’t pay.
And, since the loan is set at the rate of inflation, the amount you owe may increase if you stop repaying but it will have no real impact on your finances.
3) Student Loans Have a Fixed Life
Depending on which loan you have taken out, the duration of the loan varies. The good news is that your debt will be wiped after a specific amount of time (around 30 years), or if you become unfit to work (permanently) or if you die. This means that, unlike other forms of debts, your debt is NOT passed on to dependents, which is a big deal.
STEP #3: If You Have Multiple Debts, Pay Off the Others First
It is to your best advantage to focus on repaying the debts with the highest interest rate first, rather than your student loan. This is because the debts with the highest interest rate will grow before you know it so you do want to make them old news the soonest possible. So, before doing anything with your student loan, whose interest rate ranges between 1.25% and 3.1%, first pay off the debts coming from other loans, cards, or hire purchase.
STEP #4: Save or Repay?
Definitely, save. If you have a post-1998 loan and spare cash to clear it, your best option is to refrain from paying such a cheap loan off more quickly than necessary. Here is why:
1) Your Savings Can Be Huge
For the basic-rate taxpayer, the cost of a student loan is usually way lesser than the interest they can earn in a top bank account. If we take into consideration the fact that all savings accounts now give you ALL the interest (tax-free – see Personal Savings Allowance introduced April 2017), it is much better to save any excess money you have (instead of repaying a cheap loan).
In other words, if the loan is costing you less than what you can earn from after-tax savings, then saving is probably a better option for you. Now, you may think that the current savings rates are rather low so “Is saving still worth it?”. I bet there are a few accounts that comprise a much more beneficial deal for you than paying off a student loan taken out after 1998. BUT, if you are over your personal savings allowance, then the taxes you will pay on your savings make saving a deal you could pass.
- Always bear in mind that student loan rates are dependent on interest rates. If the interest rates go up, the loan rates could as well go up too. If this is a concern, I suggest you make sure you have easy access to your savings so that you can repay the loan any time you feel you must.
- For student loans taken out before 1998, the situation is different because the current savings rates don’t beat the student loan interest rate. Although this could turn around in the future, I won’t blame you if you start thinking about clearing the debt. Before you do, though, kindly read the next section first (#2 below).
2) Avoid Risking A Need For a More Expensive Loan In The Future
In our experience, the overwhelming majority of loan holders that pay their debt early tend to need to borrow again in the future (and do so at much higher rates than before). After you clear the debt, you may be debt-free for a while. This could change in the future, though, depending on your changing needs (i.e. you may wish to start a new business).
Paying off your student loan sooner than required, instead of saving, could put yourself at risk of having to replace it after a while with a commercial loan with soaring interest rates. Let us not forget that the student loan has added advantages you should seriously consider (i.e. if you don’t have enough money to repay, you simply don’t need to pay). Plus, any loan (even a mortgage), costs more than a student loan over the long run (think of the commercial interest vs. student loan interest). So, if you believe that you will most likely need to borrow money again in the future, consider focusing on building up your savings. That way, you will need to borrow less from a bank when the time comes.
3) Why Not Put Any Spare Chunks Of Cash Towards a Deposit?
If you have extra cash and are between two options: (1) save for a mortgage or (2) pay off your student loan, I suggest you go for the deposit.
Don’t think that having a student loan will hurt your credit score. First of all, it won’t show up on your credit record (though lenders may ask you if you are making any debt repayments or have any loans), and secondly, it may cause you to borrow a slightly lower amount as you are making student loan repayment, but these considerations are always taken into account regardless of the type of loan or other financial commitment.
This means that you will have no problem getting a mortgage. In fact, if you decide to save money instead of paying back your cheapest loan ever, you will also have spare cash to put towards a deposit!
Needless to say, you need to have self-control to succeed. If you are not too confident about your ability to keep the money you will save for a future need, then, by all means, do what makes you feel more comfortable. Better play it safe and overpay the student loan than having debt spiral.
Finally, if you have a pre-1998 student loan and know for sure that you will not need to borrow in the coming months or years, then repaying your student loan is your best option, based on the maths.