When students shouldn't pay off their loan
Student loan interest rates have jumped to a huge 5.3 per cent for 100,000s of people across the UK. And with rates soaring, many are asking: "If I have got spare cash, should I use it to pay off or reduce my student loan?"
Your interest depends on the loan type
There are two different types of official student loan.
● Student BEFORE 1998. Your loan interest is now 5.3 per cent (was 4.4 per cent). The rate is set annually, based solely on the prior March's inflation rate (RPI). Sadly, that was a big 5.3 per cent, so 320,000 graduates now pay £530 interest a year per £10,000 owed.
● Student FROM 1998 onwards. The interest remains at 1.5 per cent rate, but that could change.
The rate is set at the prior March's RPI (5.3 per cent). But a clause says in the unlikely event that the Bank of England base rate + 1 per cent point is lower than RPI in any month, you only pay that. Well we live in unusual times, so as the base rate's just 0.5 per cent, this unlikely event's happened for a few years. This means if you are one of the 3.9 million with these loans, you currently pay 1.5 per cent. But if base rates rise, the student loan rate will immediately follow - up to 5.3 per cent (was 4.4).
1) They have no 'real cost' of borrowing
Student loan interest is never more than the rate of inflation. Borrow enough to buy a shopping trolley's worth of goods and you only repay whatever the same shopping trolley costs. Borrowing has not diminished your spending power. This will change for new 2012 students (see www.moneysavingexpert.com/students2012).
2) If you don't earn enough, you don't need to repay
Unlike commercial borrowing, you only have to repay if you are earning over a set amount. This applies even if you have started paying and then your income drops. For post 1998 loans you pay nine per cent of everything earned over £15,000. For pre-1998 you only pay if you are earning over £27,700.
3) Loans get wiped
The debt doesn't last forever. Depending on when and where you studied, the debt is wiped even if you have not paid it back. For some it is at age 50, 60 or 65, others 25-35 years after studying. See www.moneysavingexpert.com/studentloanrepay. The debt also clears if you die.
Should I pay mine off?
● First use any cash to pay off higher interest-rate debts as the higher the interest, the quicker they grow.
● Even if you are debt free, for most the answer is no. For post-98 loan holders, the interest savings pay is more than student loans cost. So you are better off saving than repaying the debt.
It is different for graduates with pre-1998 loans at 5.3 per cent. Then at current savings rates, you can't outdo the student loan interest rate (though this may change). Even then, do remember that pay it off early now, and if you later need more expensive borrowing from elsewhere, you are effectively repaying student loans only to borrow elsewhere at higher, commercial rates. If that is likely, dunk it in the top savings account to minimise the interest impact.
The only exception is for those with no self-control. If you will just spend or waste the cash, then at least overpaying the student loan is playing safe.