Should you repay your student loans early?

 

 

The previous blog post explained the benefit from a 50k gift, interest free loan, or 3% loan. If you do not expect to earn enough over the next thirty years while you are working it is better to take a student loan. Then the repayments on the student loan are lower – no point borrowing money elsewhere. You would pay back more.

The same is true for early repayments. If you earn over a certain amount, it makes sense, otherwise do not bother. Your student loan repayments over the term of the loan will be less.

However, even if there is a tiny amount outstanding on your student loan, you are still liable to repay the student loan repayments. So if you want to benefit from an early repayment you really have to clear the whole loan quite quickly, repaying everything, to stop being charged further student loan repayments.

Now here is the magic number for repaying your £50k loan early:

Over the next 30 years you would have to earn approximately £1.6 million. That is a £28k starting salary, going up by 4% each year. The more you earn, the more it becomes attractive to repay early.

Here is a table to summarise all that information. (Gifts and loans were discussed in the previous post)

Decision Table
So if you expect to earn more than £1.6m and you have some spare money, repay early.

But only if

(A) the sum repaid to clear the student loan completely IS SMALLER THAN
(B) the sum paid to pay all remaining student loan payments over the rest of the term.
Remember:

When calculating these figures you will have to adjust each annual payment to account for the inflation up to then.

At £1.6m it only just is worthwhile if you repay it within the first 5 years of graduation. And at higher earnings level, too, it would be most beneficial to repay as quickly as you can.

 

 

There are three further points to add:

(1) Time value of money

 

Would you rather have £50k today or £100k in 30 years time? Clearly £50k now, as in 30 years you might be dead. However, adjusting for 2% inflation £100k will be worth only £55 in 2047. So purely from a financial point of view you should probably take the £100k then, rather than the £50k now.
For repaying loans the time value of money works against you. To repay £55k in thirty years time you would need £100k now.
Others, like Martin Lewis, might advice against repaying early, as you might have use of the funds for other purposes. Here we just assume you have enough money to repay early or not. Should you repay the loan, purely from a financial point of view? (The alternative would be to use the money to supplement your income.)

(2) Who will get really stung by student loans – and lose out from early repayments?

These are the students earning from £1.6m to £2m over 30 years.

 

Middle Earners

 

Only students earning of around £2m will through normal student loan repayments clear their debt. But it will make sense to do so early from £1.6m earnings onwards, as the projected loan repayments will be more expensive than the early repayment.

The problem with student loans is that the interest rate is extortionate. The government borrows for virtually nothing, and it lends money onto students at 6.1%. That means that unless you tackle your student loan early, will make it impossible to repay past the first few years. It would cost more after a few years to repay  than staying with the Student Loan Company. The accumulation of interest and low regular student repayments at the beginning of 30 year repayment period work against you. Unless you earn more than £55k, the interest at 6.1% will exceed your repayments from a normal student loan. Until you earn more than that, your loan will keep going up and up.

So most students who would benefit repaying early will be caught out. Uncertain if they will earn more than £1.6m they will probably stay in the student loan system in the beginning. Now they could be stuck, due to high interest rates. Should they end up with just under £2m earnings they pay close to £200k gross of their earnings to have £120k net just to clear interest, repay loan and still have a tiny bit of student loan left, which will then get written off.

 

Even at £1.6m earnings they need to earn £142k gross to repay £85k.

It is these middle to high income earners who will now subsidise the student loans system on behalf of their lower earning graduates of their class.

 

The government estimates the benefit to graduates of a degree to earnings of about  £210,000 on average. It is worth noting that advantage is largely eroded for the middle to higher earners by these large contributions to the Student Loan System.

 

Let us be clear:

The students who had rich parents never will have had student loans in the first place.

The students who will become really rich quite quickly (earnings over £2m, or good potential to exceed £1.6m) will quickly bail out from the student loan system, not wanting to subsidise the low earners.

It is the middle to high income earners who to an overwhelming extent finance the student loan system.

Another study comes to similar conclusions.

 

(3) Will £21k thresholds be increased

As rich students bail out from the system as early as they can, the remaining students will have to come up with an even higher proportion of the total to repay. As that becomes apparent, the threshold of £21k at which students will repay is very unlikely to be increased. The government wants more money to meet an increasing shortfall. Increasing the threshold would mean less money.

 

Summary

  • It makes sense to repay £50k student loan early from £1.6m earnings upwards
  • Most students will not make decision early enough to repay straight after graduation, impossible to repay later as that extortionate interest will make it impossible afterwards.
  • Student Loan System is underpinned by medium to high earners, it is them who pay through the nose to subsidise their lower earning graduates in the same peer group. By paying  more than they should due to usurious interest rates, they are forced into a system which punishes this sub-group of graduates at the expense of very rich, and very high earners.
  • The highest earners can bail out early and only subsidise the students on low earnings to a tiny extent.
  • The richest students, who did not need to take out student loans, do not pay anything to subsidise the student loans system.
  • Thresholds of £21k unlikely to be increased as greater shortfalls become apparent as really high earners bail out early
  • If you owe less than £50k on a student loan, the total 30-year-earnings at which it becomes sensible to repay early falls, of course. Conversely, if you owe more than £50k, than you would have to earn more than £1.6m in the next 30 years before it becomes sensible to repay early.
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