Student loans can be a confusing and daunting topic.
If you are a university student in the UK, you will certainly know of them, but maybe not know much about them.
Apart from knowing that one part is paying for your education and another part is contributing to your rent and takeaways, and that you are going to need to repay it all at some point is the extent of most people’s knowledge. This was also the extent of my own knowledge about student loans until very recently, which worried me. A lot.
There are so many questions surrounding the topic that I didn’t really know or understand.
Should I pay off my student loan as soon as possible?
How do I pay it back?
How much interest will I be charged?
Probably the most important, should I be worried about my student loan?
To clarify all of this and more, I started doing some digging. I did research into pretty much every area and found some extremely detailed stuff especially on moneysavingexpert.com
So here is my guide on student loans. I feel like I should have been told about how this stuff works in high school before I left for university, or at least when I got to university so I knew what I was dealing with.
This guide is for people like me, an English student who started university after 2012.
If you don’t fall into this category, then I would also check out the MSE website. The way it works for English, Scottish, N.Irish and Welsh students is very similar, but there may be very slight differences that you probably should familiarise yourself with.
How Are Student Loans UK Repaid?
By reading this guide, I am going to assume you are somewhat familiar with the system and will know what I am referring to when using words like tuition loans, maintenance loans and interest. If you aren’t familiar with these concepts then you might be in the wrong place for now…
Ok, so here we go.
If you earn less than £25,000 per year, you don’t repay anything until you do.
Your student loans start repaying the April after you graduate (if you are earning more than £25,000) at a rate of 9% on everything you earn over £25,000 each year. If you earn £35,000 per year, then you pay 9% on £10,000 (35,000-25,000) which means you would repay £900 that year, or £75 each month.
These installments are automatically taken from your payslip every month by your employer, so it is money that you will never see and you don’t need to manually do anything to pay it. If you are self-employed however, you will have to pay it yourself via your tax return form that you fill out each year.
The most important misconception and the thing you need to know: The amount you owe does not affect how much you repay each month.
If you have £20,000 in student debt and earn £35,000 per year, you pay back £75 per month.
If you have £100,000 in student debt and earn £35,000 per year, you pay back £75 per month.
After 30 years, the student debt is wiped clean.
Redefining Student Loans
So as we have already seen, you don’t pay anything if you earn below the threshold and pay back a solid and consistent 9% on everything you earn over the threshold, which is currently £25,000. It is also deducted through the payroll. You don’t even see the repayment.
Sounds a lot like a tax right? That’s because it basically is.
Many people have been campaigning for student loans to be renamed as an ‘additional graduate tax’. It may sound a little scary but it is a lot more accurate.
You earn less, you pay less back. 9% of £35,000 is less than 9% of £70,000.
It is essentially a no-win, no-fee system which intuitively makes sense; if you benefit from the education and get a high salary, you pay back more. If you don’t benefit as much, you pay back less.
Here is a table explaining how repaying student loans is essentially the same as an extra 9% tax on your earnings.
Table via: MSE
Student Loans – How The Interest Is Calculated
You may or may not be aware that the loan that you have taken out, most likely from Student Finance England, comes with interest.
This means that on paper, you need to pay back all of the money you took out PLUS extra money.
Here is the boring bit about how it is calculated…
The student loan interest rate is the RPI rate of inflation (the inflation rate of the country in March of that year) + up to an extra 3%, depending on how much you earn.
Sounds a little confusing, so here is are 3 different scenarios:
The RPI rate of inflation in March 2018 was 3.3%. That means for student loans taken out for September 2018, the RPI rate of inflation will be set to 3.3%.
If I earn under £25,000 a year, I get charged just the RPI inflation rate on my loan or 3.3%. In terms of paying back, the interest rate = RPI rate of inflation. This means I am getting charged an extra 3.3% on my loan, but costs and prices in the economy are increasing at 3.3% too (this is in very basic terms what the RPI shows). Therefore they cancel out and it is like I am being charged no interest.
If I earn over £45,000, I get charged the RPI + 3%. In this case, I am going to be paying back an extra 6.3% total on my loan, as the RPI is currently 3.3% + an extra 3%. The RPI can and does of course change.
If I earn between £25,000 and £45,000, I get charged the RPI + anything up to 3%. So for example, if I earn £35,000 per year, which is halfway between the two, the interest would be half too. So RPI + 1.5%, which is currently a total interest charge of 4.8% (3.3 + 1.5).
Why The Interest Rate Probably Doesn’t Even Matter
Why doesn’t it matter to most? Because most of us aren’t going to get round to paying it anyway.
In fact, a lot of us aren’t even going to completely pay off what we originally took out in student loans, nevermind the added interest.
Even more surprisingly a study from IFS shows that 83% of English students with student loans will never fully repay what they owe before the 30 years is up. 83%.
You can test this yourself via the student loan calculator, which is a pretty cool tool.
I plugged this example in:
4 Year course, Tuition £9000 per year.
Maintenance loan around £3900 per year.
Likely starting salary I put it as the UK graduate average: £23,000, but you can play around.
Average inflation each year (RPI): 3% (default)
Your salary growth per year: 2% (default)
With these variables, the calculator estimates that by the time my student loan expires in 30 years, I will have paid off just £9550! Calculated with inflation is just £4650 in today’s money!
Of course, the rate of inflation is just an estimate, salary growth is just an estimate and the calculations are based on the current system, all of which could of course change.
But the point remains the same. I will have around £50,000 in student debt by the time I graduate, plus all of the interest that will be added over the years. The debt is huge, but it doesn’t matter, because remember: You are charged on what you earn, not what you owe. It is very unlikely I will pay off the full sum before it is wiped in 30 years.
Student Loans UK – A Summary
Unless you are almost certainly destined to be a big earner coming out of university and are likely to have large salary increase throughout your career, there isn’t much point in overpaying your student loan or paying it up front, as you will be chucking money at a total sum that you probably won’t fully pay off anyway.
If you are taking time off work for things such as mini-retirements, maternity/paternity leave etc., you will most likely be paying back even less.
This is a very unique loan in that essence, as I would otherwise encourage wiping off debt as soon as possible in every other ‘standard loan’ scenario.
But the student loan is different, a bit like a tax, a contribution to your education.
Student loans tend to cause more psychological discomfort than financial discomfort.
I hope this post has relieved at least some of the psychological discomfort.