The real cost of student loans. It’s the gross income which is relevant!

Any parent currently thinking about sending their kids to university will want to know if it is worth it financially.

Advice is hard to find. On the one hand 1/3 of students regret taking their degree and 50% regret getting into student debt. On the other hand students are encouraged to take up the loan, £50k (or more) as the “real cost” are only 9% of earnings over £21k. For the next 30 years. If it is not repaid, it will be written off by the government.

If you do not have any other source of finance and want to go to university, you do not have a choice but to take out the student loan.

On the other hand, what about the many students who enter university from fee-paying schools? Their parents will have paid for their schooling, and could now pay for their university tuition and maintenance. Unless rich parents believe their children will do substantially worse than themselves (their offspring might prefer to hit the surf or the slopes rather than work in the UK) they will presumably consider paying  for their university tuition fees.

And it makes sense. If you have to earn money to repay the loan, you will always have to pay tax, student loan repayments, and interest. So you have to earn substantially more than £1 to repay £1.

Example 1: £10k loan interest free.

What will it cost to replace £10,000 of tuition fee paid straight  by the parents.

Even if the graduate were to repay the £10,000 straight away after graduation, assuming 0% interest, the graduate would have to earn

£14.7k (basic rate taxpayer)

£17.2k (higher rate taxpayer)

Because the marginal tax rates are

basic: 32% (20% tax and 12% National Insurance) (so £10k/(1 – 0.32) = £14.7k)

higher: 42% (40% tax and 2% NI)

 

Example 2: £10k student loan is interest free but follows student loan repayment regime:

To repay £10k of student loans using the current repayment scheme (9%) you would have to earn

£16.9k  (basic rate taxpayer)

£20.4k  (higher rate taxpayer)

The marginal tax rates have now increased to

basic: 41% (20% tax and 12% National Insurance and 9% Student Loan Repayments)

higher: 51% (40% tax and 2% National Insurance and 9% Student Loan Repayments)

 

Example 3: Assume £10k is borrowed as part of a 3% mortgage, and will be repaid in a lump sum either in 10 years, 20 years or 30 years.

We also quote figures after adjusting for a 2% inflation rate. That means that 102 next year (and so on…) is the same as 100 today. So all amounts quoted can be compared to money today. All amounts are earnings before tax.

So in £10 years time you would have to earn £16.2k (basic) or £19.0k (higher)

In 20 years £17.9k (basic) or £21.0k (higher)

In 30 years £19.8k (basic) or £23.1k (higher)

to repay the loan. Marginal tax rates as in Example 1.

Example 4:  Assume £10k is borrowed as part of a 6.1% student loan, and will be repaid in a lump sum either in 10 years, 20 years or 30 years.

We also quote figures after a 2% discount rate. That means that 102 next year (and so on…) is the same as 100 today. So all amounts quoted can be compared to money today. All amounts are earnings before tax and student loan repayments.

So in £10 years time you would have to earn £22.9k (basic) or £27.7k (higher)

In 20 years £31.1k (basic) or £27.6k (higher)

In 30 years £40.2k (basic) or £51.0k (higher)

Marginal tax rates as in example 2.

These are now summarised in a table.

To repay £10k you will have to earn:

 

 

£10,000 standard rate —————– higher rate ———————-
1. Repayments £14.7k £17.2k
2. Student Loan No Interest £16.9k £20.4k
3. Loan at 3% £16.2k £17.9k £19.8k £19.0k £20.1k £23.2k
4. Student Loan at 6.1% £22.9k £31.1k £42.2k £27.8k £37.6k £51.0k

Summary

Because of tax, National Insurance and student loan repayments, you have to earn more gross to be able to repay net. If your gross earnings are your only expected income, so that is the right way to look at it. How much extra do you have to earn gross to repay £10k? The minimum is £14.1k , even if you get the loan interest free. Remember, figures in example 3 and example 4 above have been adjusted to compare to £10k today. So even though the loan goes up by 3% each year “nominal” we adjust for the fact that inflation is 2%, to give us the “real” amount. That is the only way to compare these figures.

Student Loans are the most expensive to repay when compared to other loans – up to 2.5 times more expensive when repaid after 30 years (£51k) compared to a 3% loan repaid after 10 years (£14.7k).  (Note: Nobody repays £51k in student loans in one year. But the relative costs are still the same. So £1k loan needs £1.62k in repayments after 10 years (3%), compared to £5.1k in repayments in year 30 of student loans.)

Sure, you might not repay all of your student loans, but even if you repay just 90%, 80% of them, the cost will be more than a regular low cost loan.

So why do students not take up loans other than from the student loan company? Or why do parents not pay for their children if they can afford it? Surely it will be cheaper in the long run. Or will it? Some think not.

The next blog post  tries to go into more details:  Gifts from parents, interest free loans, and very low interest loans would possibly be worth it. Compared to the expensive official student loans from the Student Loan Company.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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