Is paying off my student loan a good idea?
I can answer that question in two words: It depends.
Yep, not the answer you were expecting, sorry.
Student loans are tricky. Some people don’t know whether to pay them off or not and some hesitate getting one in the first place. Are student loans really worth it? Will they cripple me for the rest of my life? The simple answer to all those questions is: do your research. Get educated on student loans; talk to other people who have them, call Gov.uk, ask your university. Only then, can you make a decision. This article is a good start to understanding student loans, but after that, it’s important you do some more research.
What is student loan debt?
Student loan debt is the strangest and most different form of debt you’ll ever come across. It’s very cheap, and it can be the difference between a job or not. In fact, many people disagree that it should even be called debt in the first place. More details below…
Student loans are a great 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.
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
You may look at the numbers and think ‘Oh wowsie, I’m graduating with £40,000 in debt’, after this little intro article you’ll realise that it actually doesn’t matter how much you owe, what matters is how much you’ll repay.
From the United States? Your student loans work a bit differently – they are still a form of financial aid but they can come from the government or a private lender. Some lucky people are eligible for loan forgiveness programs depending on the line of work they go into but it’s rare, the majority of people start to make repayments on their student loans the year after they leave studying. There are companies such as SoFi who can help you to fund further higher education.
How will I pay it off?
The laws and rules keep changing – last year the salary allowance before paying back your loan was £21,000. Since April 2018, it’s £25,000. So by the time you read this, things may have changed. Which is why: DO YOUR RESEARCH (there are some resources at the end of the post)
Anyway, this is how the program works now, August 2018.
It all depends if you’re on Plan 1 or Plan 2
Plan 1: an English or Welsh student who started their undergraduate course before 1 September 2012, or a Scottish/Northern Irish student. Interest on the loan is 1.5%
Plan 2: an English or Welsh student who started your undergraduate course on or after 1 September 2012. Interest on the loan is 3%
Depending on what plan you’re on, you will repay different amounts. As most of you will be in Plan 1, here is how you will be repaying your loan:
First of all, you only start repaying anything until you earn more than £18,300 a year. 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 table from the Gov site to make things clearer:
- So if you earn £40,000 a year, you’ll pay back (40,000-18,330) * 0.09. So £1,950.3 for one year. Not too bad.
- If you have several jobs or other complications, check out the Gov site for more info (pretty well explained there)
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 £18,330 for 30 years, you won’t ever repay anything. If you earn £20,000 for 30 years you’ll only repay £4,509 of those £40,000 (although it’s unrealistic). See where I’m getting at?
This is why some 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 when you’re earning an income. A system which is much more generous and helpful than the US one, I believe, and with just as good an education system.
You may have realised 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 £6,670, so £600.3 every year – just one will pay them off sooner because of the smaller loan.. It really is all about the salary.
So how do I decide?
There are two aspects to the decision: financial and psychological. The financial one means putting numbers together and figuring out which option works best for you. The psychological one is just as important: how do I feel paying for my loans for 30 years? Would you feel better if you paid them all off?
This is important because debt can be a huge burden on people’s minds, it can make you feel trapped, caged into the system. If you don’t want to feel that way, then paying back your loans could be your answer.
Anyway, let’s go into specifics and look at two examples of people paying back their student loans:
- Luke graduates university with £52,166 in student loans. He gets a job earning him £27,000 a year. £27,000 is £8,670 above the £18,330 threshold, so he will contribute back 9% of £8,670 = £780.3 in the first year. If his salary doesn’t change at all (unlikely), he’ll have paid back the equivalent of £23,409 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
- Alice 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 15 years to pay off the entire student loan, and by then the total will be her loan + interest. She decides that she could afford to pay them off early to not pay more interest, and in 5 years she puts in early payments to pay it all off.
So once again, as you can see, it all depends on your salary, how much you’ll be paying back in total and how long it will take you.
What I recommend: whip out your calculator and get to the numbers. Calculate and write down the following:
- Your annual salary
- How much you will pay in student loans IN TOTAL, for the next 30 years (you can also use the calculators above to help out)
- How much you will pay IN TOTAL if you paid them all off right now
If the number between paying them off now or paying them off over the 30 years is very large, consider paying them off early if you feel capable. If not, it may not be worth it. But also take into account the psychological aspect – how would you feel if you paid them all off?
That’s as specific as I can get, because when it comes to student loans, it’s really up to you. Will overpaying significantly reduce the amount you pay over the 30 years? If the amount is significant for you, then go ahead, but if it has not much impact, you might be better putting your money into something more productive: investing, emergency fund, future large expense.
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.
Oh, and if you have credit card or consumer debt, definitely attack that one first before student loans: they have a way higher interest rate and can be an unhealthy cycle. Once that’s done, take over the student loans.
Anyway, I hope this article has given you a bit more of an idea on what student loans are all about and whether you should pay back for them or not. Have you reached a decision? What are you going to do? Here are some resources to get you started on the right path: