Should I Overpay My Student Loan

INTRODUCTION • WHY DO LOANS EXIST • WHAT ARE THE PLANS • WHAT WILL I PAY • WHAT IS THIE INTEREST RATE • WHAT IF I DONT REPAY IT • WHAT HAPPENS WHEN ITS PAID OFF • SHOULD I OVERPAY • FAQ • KEY TAKEAWAYS

Introduction

So you've graduated with a few tens of thousands of pounds of student debt and wondering how you're going to repay it all with interest on top. Some graduates will repay the whole loan and others are unlikely to pay it off at all.

Why Are There Student Loans In The First Place?

Student loans are for two different reasons, one of them is to pay the university for tuition and one of them is so you can live (this is called a maintenance loan). You will never see the tuition part of the loan as it goes right to the university but the maintenance loan will be paid to you in instalments, just so the less careful students don't blow through it all in the first week!

The amount a university is allowed to charge for tuition is currently capped at £9,535/year and will probably continue to increase. The maintenance loan amount depends on your parents earnings and you could also be eligible for a grant which doesn't have to be paid back and doesn't add anything to your loan.

To get student finance, you must apply to Student Finance England (If you are in England) and they will guide you through the process.

What Are The Repayment Plans?

There are 5 different repayment plans and the one you are on, and the payment details, depends on when you started your course and what type of course you did.

Plan 1:

You will be on plan 1 of you started your course after the 1st of September 2012.

Plan 2:

You'll be on plan 2 if you started your course between the 1st of September 2012 and the 31st of July 2023.

Plan 4:

Plan 4 applies to all and only Scottish students

Plan 5:

You'll be on plan 5 if you started your course on or after the 1st of August 2023

Postgraduate Loan:

You’ll be on a Postgraduate Loan plan if you’re studying a postgraduate master’s or doctoral course.

Now you know what type you have, lets talk about how much and when you'll repay.

What Will I Pay?

All loans will be paid from your salary above a threshold. This table shows the threshold for each plan:

£33,000 - £28,470 = £4,530

£4530 x 9% = £407.70

which equates to £33.98 per month

So if you earn less than the threshold you won't pay anything towards your loan, although the interest will build up and the size of your loan will increase!

If you're on plans 1, 2, 4, or 5, you will pay 9% of your salary that exceeds the threshold and 6% if you are on a postgrad loan. For example:

If you are on plan 2 and earn a salary of £33,000, the amount above the threshold is:

What Is The Interest Rate?

The interest rates are fairly easy to understand if you're on any plan other than 2. For plans 1, 4, and 5 you're charged 3.2% starting from the first payment made to either you or the university you're studying at. For a postgrad loan, it's 6.2%.

If you're on plan 2, it's not amazing. You're charged 6.2% while you're studying then once you graduate, the interest depends on your income. If you earn £28,470 or less, it's 3.2%. For a salary between £28,471 to £51,245, you have a gradual scale that reaches 6.2% at the top of the band. Then anything over that remains at 6.2%. Just to be clear, this interest rate is applied to the entire loan so they really hit you as your salary increases.

With an average debt of £53,000 when graduating, someone on plan 2 would accumulate at least £1696 a year.

What If I Don't Pay It Off?

If you don't pay it off, there are no consequences like there would be with a mortgage or other loans. Below shows when Student Finance will wipe your loan.

Plan 1:

If you received your first payment before the 1st of September 2006, your loan will be written off when you turn 65. If it was on that date or later, it's 25 years from the April you're first due to repay.

Plan 2:

It's written off 25 years from the April you're first due to repay.

Plan 4:

If you received your first payment before the 1st of August 2007, your loan will be written off when you’re 65, or 30 years after the April you were first due to repay – whichever comes first. If it was on that date or later, it's 30 years from the April you're first due to repay.

Plan 5:

These are written off 40 years after the April you were first due to repay.

Post graduate:

Your Postgraduate Loan will be written off 30 years after the April you were first due to repay.

Looking at these, there's not that much pressure to pay it off but it's been designed to cover most people's working life and most people do earn over the lower threshold at some point in their career.

What Happens When I Pay It Off?

If you paid it off with basic salary contributions you'll get a large pay rise as any cash you were paying into the loan will remain as part of your pre-tax income. Sadly, the tax man will now take a larger part of your income to match what he would take from someone without a loan (assuming the same salary). The other alternative is to overpay your loan so it is paid off faster and you enjoy that pay rise for longer.

Should I Overpay?

In short, probably not. To illustrate this, I'll use a few diagrams based off plan 2:

Assuming a salary of £33,000 with an annual 2% rise, this shows the value of your loan (Including your payments) over 30 years. Clearly, at that salary you loan will not be paid off despite payments of almost £44,000.

Lets increase the salary to £50,000, also with a 2% annual pay rise, the value of your loan, over the same 30 years looks like this. It's a lot better and starting to decrease after around 27 years. Still not paid off or close to paid off despite paying £105,687 in interest.

Lets increase the salary again to £70,000, also with a 2% annual pay rise, Remember that this is a starting salary from graduation. The value of your loan, over the same 30 years looks like this. Now within around 20 years the loan can be paid off after paying a total of £104,000. Less than the person who started on a salary of £50,000!

Personally, I don't know anyone who graduated right into roughly double the UK average salary. If you did, or are going to have a pretty steep salary trajectory, you might want to make over payments. In the £70,000 salary above, assuming you will work for another 10 years after the loan is repaid, you'll have another 10 years to enjoy the roughly £7,000/year that you were paying to student finance as your loan got to zero.

If you want to plug in your own values, sign up to the mailing list and I'll send you the template I used for these charts.

FAQ:

Can I salary sacrifice to avoid paying it?
Sadly not, the only thing you can do to avoid paying is to keep your pre-tax salary below the threshold of £28,470. If you were to have a large lump sum that you could get into an ISA, any interest there could support a shortfall if you can't/don't want to live off less than that. For more information on ISAs have a look at this post.

Does my loan impact my credit score?
No, having a student loan of any size does not have any effect on your credit score.

Can I get a refund for my overpayment?
No. If you decide to make an overpayment, that money is gone as soon as you make the payment.

What if I move abroad?
You'll need to let Student Finance know and continue to make payments.

Key Takeaways

If you've read this article, the chances are that you have already graduated so I hope this has provided some clarity for you. If you have not yet started university, please have a think about the value you get from it as it'll likely be the largest loan of your life other than a mortgage. If I had read this when I was 18, I probably wouldn't have gone to university but would have become an electrician earning around £400/day (£100,000/year) and not having a student loan!

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Disclaimer

The usual disclaimer: I'm just a guy on the internet sharing what I've learned. This isn't financial advice so do your own research and speak to a qualified adviser about your specific situation.