The previous blog post showed you how much more expensive it is to take out a 6.1% student loan from the government compared to a 3% loan. That is due to higher interest rates, taxes, national insurance and additional student loan charges.
Students should therefore, before taking out a student loan, consider some alternatives:
There is a myth out there that the cost of the student loan repayments do not matter, as most students will not clear the outstanding debt anyway. That is wrong.
If completely clearing an alternative loan is cheaper than even partial student loan repayments, that alternative loan should be considered.
Assume you are a student and have three options to pay for the £50k cost of university:
- Your uncle offers you £50k interest free to be repaid in equal instalments by you over 30 years at £139 a month.
- Your dad says he will put £50k on mortgage at 3%, to be repaid in equal instalments by you over 30 years at £186 a month.
- You take out a student loan
So how much do you have to earn if you take up which options? Remember, it is only your earnings which will determine your repayments for the student loan company.
(we assume here that neither the £21k repayment threshold will change, or any other tax thresholds will change relating to loan repayments)
Take your uncle’s interest free loan if you will earn more than about £1.15m over the next thirty years. That is £25k starting salary, rising by 3% each and every year. If you expect to earn less, take the student loan.
Take up the offer of your dad of the 3% loan if total expected earnings are more than £1.45m over the next 30 years. That is either
– £28k starting, increasing each year by 3.5%, or
– £30k starting, increasing each year by 3%.
Take out a £50k student loan if you expect to earn less than either £1.15m (if you have a rich uncle) or £1.45m (if you have a helpful dad).
Or even take out a student loan if you earn slightly more than that and you value the flexibility of not having to repay in years when you do not earn.
Other things to consider:
Will repayment thresholds be increased?
If you are convinced that the government will increase repayment threshold of £21k levels upwards, or increase earnings limits, the student loan will become much more attractive than the alternatives. If the government did, you will have to earn more over the next 30 years, perhaps £200k or more (on top of the £1.15m or £1.45m) before it will become cheaper to take your uncle’s or dad’s loan.
However, since student loans were introduced, loans have become bigger, more expensive, with thresholds retrospectively frozen until 2021. So why would the government change it now back into the other direction? Especially since the Student Loan System is desperately trying stay afloat and reduce government contributions at the expense of students’. A sceptical and prudent approach is therefore justified. Assume the government will not increase thresholds.
Risk that government will change conditions to student’s disadvantage
The government considers the government debt only being repayable through earnings. But that law could be changed. Terms and conditions have been changed before for previous loans. Perhaps the government will make a student debt more like a real debt, where debt collectors can and will chase you to enforce repayment. Perhaps worldwide. There is no guarantee. In future you might get a visit from thebailiffs for missing a student loan repayment – even if you are unemployed – you never know what a government will legislate for. The student loans will certainly be sold off to a private company, they have with all existing tranches. There is no guarantee that the government will continue to be as lenient when pursuing you for your debt, or that a private company will do so in an ethically appropriate way. Do not forget that directors of the Student Loan Company have in the past been sacked for unethical behaviour.
In total, be aware that students are asked to subscribe to a Student Loan System which will probably be changed significantly. And as the government will be short of money, it might well be that it will try to enforce the student debts as rigorously as it can.
Consider a possible change of government
Remember also, student loans might be scrapped (Labour) or increased retrospectivly to the students’ disadvantage (Tory government).
Should you partly repay outstanding student loans?
This is important: once you decided to take out student loans there might not be any point to repay the outstanding balance. Only pay it back if the sum to clear the Student Loan Debt completely is less than the sum of annual repayments you would have paid if you had stayed in the Student Loan Company.
For example, 20 years after taking out a student loan your godfather might offer you to repay part of the student loans with a £50k gift. Check if it is worth it. You might repay less over the last remaining 10 years as part of student repayments.
What if you earn very little
Even if you only start on £21k and increase earnings by 2% per year you will end up earning £850k over 30 ears. You will only repay a fraction of the original £50k loan and no interest.
What if you earn a lot
You will repay all the £50k student loan and accrued interest, only if over the next 30 years you earn £2 million or more. You will if you start on £30k and your increases are 5% a year.
Should it transpire in future that you will earn £2million, but decided to take out a student loan rather than take up your dad’s offer you lose out. You will lose out by an enormous amount. You basically spend a lot more money (tens of thousands of pounds more) on your student loan repayments than you would have done had you earned £1.45m and taken out a loan from your dad.
You might be better off using alternative financing, either by getting a gift or an interest free loan (if earning over £1.15m) , or a very low 3% interest loan (over £1.45m).
That is true EVEN IF YOU DO NOT REPAY the full student loan. The only thing which matters is how much you earn. That will determine your student loan repayments, and even at medium earnings you will be better off financially taking out an advantageous loan, should someone offer it to you.
When comparing loans it is no good just to compare cash repayments amounts, but it is important how much extra you will have to earn to pay the student loan repayments, or any other loan arrangement over the 30 year term. So gross wages – before taxes and student loan repayments are important
Gross wages are your only source of income to repay any loans. As we said before in the previous blog post, to pay £1 of loans to the student loan company, you will have to earn £2 if you are a 40% taxpayer and 9% towards your student loans.
To earn £1.15m or £1.45m over 30 years, the salaries and salary progression look very average. In today’s money, that would mean salaries of around £33k or £42k at end of your thirty years, respectively. If everybody had access to these cheap funds, a higher percentage of students could repay their loans. (As a reminder, the Institute for Fiscal Studies suggested that under current student loan system 3/4 of students will not repay their loans fully!)
The usual provisos apply. If you do not work the full 30 years (career break, unemployment, illness) the student loan might be more advantageous. Although your uncle or dad might also let you off the hook should disaster strike.
No rich uncle or helpful dad?
And finally, what if you do not have a rich uncle or a dad willing to put £50k on his mortgage?
Let’s face it, that’s probably the majority.
Do not worry about it – take the student loan and repay as advertised. You now know that even people whose studies are paid for by a interest free loan or 3% interest loan need to earn about £1.15m or £1.45m before they actually get a financial benefit from these loans.
On the other hand, assume you and your friend both expect to earn £1.45m. But your friend had a helpful dad who paid for his studies with a 3% loan. Anything you can do to cut the cost of your repayments?
If you start on £28k and your salary increases by 3%, in 5 years you will have earned £150k. If you manage to repay your £50k (plus accumulated interest) student loan from these £150k earnings, you will save about £117k in future student loan payments (from your gross earnings). That is £117k, that is the money you do not need to earn to pay the Student Loan Company for the next 25 years if you manage to repay after 5 years. You will have that as additional gross salary.
Assuming your friend still has the loan from his dad, he will have to repay £61k from his gross earnings over the next 25 years.
That is what you should remember:
You should always try to clear the student debt, if you can, if the sum needed to clear the loan completely is less than the sum needed to repay your projected student loan payments.
Best would be not to get into too much debt in the first place, of course. Earn as much as you can before or during studies, borrow as little as you can. Think about delaying university entry for a year to earn some money. You might still need a student loan, but if it is £25k than £50k it is a lot easier to clear from your expected lifetime earnings. (If you expect to earn very little over the next thirty years, maybe constantly below the £21k payment threshold, you should, of course, attempt to borrow as much as possible really)
So clear the high-interest student loan as quickly as you can. It might be possible
- if you still live rent-free at your parents’ house,
- if you have a loan which is smaller than the maximum allowed,
- start early after graduation,
- and keep going without fail to do so, within the first 5-10 years if you can, or quicker, to make it worth while.
If you fail to clear it fully, you will still owe the full student loan repayments, even if you only owe £1.
It will cost you less, to clear it quickly, for two reasons:
(1) Interest will not accrue as quickly and (2) you are likely to have much lower tax rat, making repayments significantly cheaper.
Your granddad gives you a gift of £50k to pay for your education
Should you take a gift of £50k? If you expect to earn more than £1.15m, definitely. You expect you might earn less? If you expect to earn a lot less, perhaps having no intention to work, do take the maximum student loan. And use the £50k gift to supplement your income once you work.
If you expect to come close to the £1.15m over the next thirty years, but not quite over the full amount, the advice here is to take the money anyway and use it for your education.
It will save you to be in debt servitude to the UK government for the next 30 years, like some medieval peasant. You will avoid demoralising student loan account statements which will show increasing loan balances despite steady and costly repayments. Crucially, it will allow you to keep more of your earned money for yourself, reducing your tax rate by 9 percentage points, as you do not pay depressing and punishing marginal tax rates of 41%, or even 51%.
If you think that this level of sophistication and number of uncertainties are absolutely ridiculous for 16 or 17 year olds to consider, you would be right.
You would also be right in thinking it has been made complicated on purpose so that investment banks can come in and scalp the government when buying the existing student loan books, as is planned. And therefore earn money and profit from these high interest student loans – at the expense of students and taxpayers.
It is equally ridiculous that good student loan advice is not available on a government website. Or that no sophisticated repayment calculator is available which would show how the above calculations have been derived. So that students and their parents can make informed decisions.
The most astonishing fact, though, is that you are entering into an Student Loan agreement with the government, and the government has the option to change the terms of the agreement and the cost for the service/loan it has provided – in retrospect! You would not enter into any other commercial agreement on that basis. But here you are supposed to just sign up to a 30 year agreement for which you do not know the most basic conditions – such if the £21k threshold will be changed or not. You have got to be kidding.
Student Loans Company Loans – another financial scandal, this time instigated by the government itself! And let us be specific, in its current disastrous form, introduced by the Conservative government and the Liberal Democrats.
The summary of these figures now in graph format:
And here is the data for the chart
NPV is the net present value, the 2017 cash value of any money value in the future.
Let us take the £1.15m total earnings as an example. That would be a £25k starting salary, growing by 3% each year, all added up after 30 years. The sum of 30 years worth of salaries is £1.15m.
Your annual salary in 30 years time, adjusted for the net present value should be
£25k times (1.03 to the power of 30) divided by (1.02 to the power of 30) = £33.5k
The NPV uses as a discount value 2%, as it is assumed that 2% return can be achieved over the next thirty years on average on an investment.
Please note that should the government decide to increase the threshold of 21k, the green line in the graph should move downwards. But the slope would stay the same.