Student finance: to repay or not to repay?

We are in the midst of results season and whilst students may be thinking about life in September, parents are pondering the financial considerations. We thought it timely to share some thoughts on using loans to finance higher education:  

What is available under the current rules?

Many households will not qualify for means-tested support (based on household income). This means support will be restricted to the basic entitlement which is a tuition fee loan (capped at £9,250) and a base maintenance loan (typically used for rent or living expenses). The amount of maintenance loan granted is dependent on a number of factors such as living inside/outside London or living at home. 

For example, a full time student starting in September 2019, living away from home, outside of London and non-means tested could receive a maintenance loan of £4,168pa (c£1,389 per semester) on top of their tuition fee loan. Upon leaving undergraduate studies (assuming a three year course), there will be an estimated debt of c£43,000 inclusive of accrued interest. 

How interest accrues 

Whilst studying, interest on the loan builds up at 6.3% which is calculated as the Retail Price Index +3% (RPI is a measure of inflation, i.e. the change in the costs of goods and is currently 3.3%).  To put this into context, the rate of RPI +3% is the same as our long-term return assumption for a portfolio which has a 60% exposure to global stock markets.  In other words a very high rate! 

Interest applied to the accumulated debt after leaving higher education depends on earnings. The threshold is £25,725 and those with income below this will have an interest rate set at RPI. An upper threshold exists of £46,305 and for those with income above this the interest on their debt will be RPI +3%. Interest for incomes between these two amounts works on a sliding scale between RPI and RPI +3%. (It will also be RPI +3% for those who do not inform the student loans company of their job status).

What happens after leaving?

The loan begins to be repaid once the graduate’s annual income exceeds £25,725. Any income above this will have deductions of 9% which will go towards the accumulated debt. For example, an income of £40,000pa is £14,275 over the threshold, so £1,285 (9% of £14,275) will be paid annually, or £107 from a monthly salary. Any remaining debt is written off after thirty years. 

Should I repay the loan? 

Some families are in the fortunate position to be able to help their children and repay their loans.  However the way the rules currently apply makes us think that it is not automatically the right thing to do.

The mathematical argument depends on the earnings trajectory of a graduate. This can be hard to accurately estimate. An individual with a salary range of £30,000 (rising by 2.5% a year) would have made total repayments of c£49,000 and still have an outstanding balance of c£45,000 (nominal value) before the loan is wiped off at the 30 year mark. The effect of compounding interest rates causes the debt to grow but because it is written off, the effective interest paid on top of the amount borrowed is very low (1%-2%).  It is difficult to make a case for repaying the loan in this circumstance and the funds which would have been used would likely serve the individual better if they were invested on their behalf or put towards a first home.

If it becomes clear early on that earnings are likely to be high (in the six-figure region) and get there fast, then paying the loan off would be a sensible thing to do.  This is due to the fact that the total loan would be repaid and a very high rate of interest would apply.

The good news is that there is no need to rush in making a decision. Take time to consider the young person’s direction in life and what is the likely trajectory of their earnings. The interest accrued during this time is not likely to be make or break so there is no need to make a panicked decision. If it appears that earnings are on a steep upward trajectory, then paying the loan off might be worth thinking about.  Who knows, the rules may change again during the period too!

Other factors

There are other factors to consider outwith just the mathematics. A couple of examples are: 

1. Even if not needed, taking the student loan can act as a motivator to some students as it can provide an incentive to study hard. 
2. The 9% deduction can have a material impact on a monthly salary during the early period of a career. It could impact the thinking of some and curb motivation.
3. Legislation changes will almost certainly impact the strategy for student loans and loan repayments over the next thirty years. 
4. Taking the loan could normalise the idea of debt in the mind of the young person

Student finance can be a way of initiating important conversations with children about good financial health such as credit, debt, saving and budgeting.  We love getting involved and helping our families navigate this challenge which is one of the reasons we offer free financial advice to children of clients under the age of 25.