Should I pay off my student loan early?


This is an audio transcript of the Money Clinic podcast episode: ‘Should I pay off my student loan early?’

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Claer Barrett
Every year, over 2mn students graduate from university in the UK. And the majority who start their working life tens of thousands of pounds in debt.

James
I did do a four-year course, which is four times 9,250, and also with a maintenance loan as well. And so in total, I think my student debt was around 63,000.

Claer Barrett
That’s James. He’s 23 and he’s just starting out in a graduate job in financial services. But here’s the thing. While he’s about to start earning for the first time, he’s also about to begin making repayments on all of that student debt he’s built up. And his interest rates are rising. James is concerned this will have him paying back more on his loan in the long run.

James
At what point would it make sense for a high earner such as me to repay their student loan early?

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Claer Barrett
Welcome to Money Clinic, the weekly show from the Financial Times about personal finance and investing. I’m Claer Barrett, the FT’s consumer editor. This week we’ll be discussing student loans. Should we even be calling them loans or treating them more like a graduate tax? How does the amount you earn affect the amount that you’ll pay off over the long run? And at what point, if ever, should you consider paying off your student loans early? Answers are coming up, but as always, please be aware that the view shared on the podcast are just that — people’s opinions. Money Clinic does not constitute investment advice.

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First things first: how do student loans work? Well, there are actually different types of student loans depending on when you started university and where you’re from. In this episode we’ll mainly be discussing Plan 2 loans. That’s for graduates from England or Wales, who started their undergraduate course in 2012 or later.

Ben Waltmann
So for people like that, there are basically two bits to the student loan. One is tuition fee loans . . . 

Claer Barrett
That’s Ben Waltmann. He’s a research economist at the Institute for Fiscal Studies, an organisation that crunches numbers on UK policy and economics. The tuition fee loan he mentioned is up to £9,250 a year and most undergraduate courses last three years. So you can rack up three times that.

Ben Waltmann
And then in addition to that, people are entitled to a maintenance loan to help cover their living costs. And that depends on some circumstances, how much people are entitled to. But it’s going to be between £3,500 and £12,000.

Claer Barrett
Plus, that loan amount starts to accrue interest even while you’re studying. You can see how the numbers start to add up. But what about repaying the loan?

Ben Waltmann
You start repaying in April after you’ve left your course. And from then on, people pay 9 per cent of their earnings above a threshold which is £27,300 at the moment.

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Claer Barrett
This is a key point, and it’s why many people prefer to call the student loan a graduate tax. That’s because the money you have to repay each month is relative to the amount you’re earning, not to the size of the debt. Here’s how to think about that: £27,295 is the repayment threshold that we were just talking about. When you earn more than that, you pay back 9 per cent of anything you earn above the threshold, not 9 per cent of your entire pay cheque. So let’s say you have a salary of just over £28,000 a year. That’s £1,000 above the level of the threshold. A 9 per cent slice of that would be £90 a year, or break it down, a repayment of £7.50 a month. But someone on a salary of £60,000 has nearly £33,000 of income above the level of that threshold. Nine per cent of that is just under £3,000 a year, a repayment of around £245 per month. But while your repayments are fixed, the interest on your loans will build over time. The rate you’re charged depends on your income, but it’s currently capped at 6.3 per cent. And the other key detail about the student loan is that it gets wiped after 30 years. So say you never earned over that £27,295 threshold. Well, then you’ll never repay a penny of your debts.

Ben Waltmann
And so that’s very different from, say, a mortgage where your monthly repayments might depend on the interest rate.

Claer Barrett
This is a really important point. If you’re never going to earn enough to pay off the loan, then the interest rate really doesn’t matter. You could have 1mn per cent interest, but your monthly repayments would remain the same. OK. That’s the nuts and bolts of student loans done. Let’s hear a bit more from James. He’s been enjoying a bit of post-graduation travelling before moving to London to begin his career in finance.

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What kind of salary expectation do you have? Are you starting off on quite a good wage, I’m imagining?

James
Yeah, relatively good. I’d say around about 60,000.

Claer Barrett
OK. I mean, for a guy in his early twenties that’s certainly pretty tasty. But then having nearly £63,000 worth of student debt, I mean how does it feel just looking at that number.

James
(Laughs) Mmm, yes, it feels like it’s, it’s quite a weight, really. And knowing that there may be the next like 20, 30 years that I’m going to be paying that amount. It’s almost like an extra tax on top of tax I’m already paying.

Claer Barrett
I mean, what options are you considering when you look at your student debt?

James
My instinct would be to leave it how it is, pay off that 9 per cent as a sort of tax and keep going with that and then hope that my salary is high enough to pay it off relatively quickly.

Claer Barrett
OK. That sounds pretty sensible to me. But it has crossed your mind: maybe I should try and accelerate the repayments. What is it that’s making you worry about that? Is it the interest rate that’s being charged on your borrowings?

James
Yes, I think it’s like, it’s a combination of high inflation, which means that there’s a high interest rate being charged.

Claer Barrett
Mmm.

James
And also looking at the current financial markets and thinking, would I get much of a return on my investment if I’d invested in them? It’s like the war in Ukraine, inflation. I’m thinking, how much money am I actually gonna get from an investment in an index fund? And then if I’m not going to get much money from an investment, maybe I’m better off paying off that student loan early instead.

Claer Barrett
But do you think that your salary expectations will also be a factor in whether or not you should pay off your loan early?

James
I suppose if you earn a lot more than you’re gonna end up making that student loan debt smaller and smaller over time. And so you’ll end up paying the student loan off before the final deadline.

Claer Barrett
Mmm. Because you’ll be earning a lot over that £27,000 threshold.

James
But if you only earn a little bit over that threshold, then your payments are never gonna keep pace with the interest that is added to the student loan every year. And therefore it wouldn’t be worth paying it off because you’re never going to reduce that debt to zero. But then the question is, would I be able to get a better rate of interest if I invested that money instead of using that money to pay off my student loan or not?

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Claer Barrett
So should someone like James try to beat the added interest and pay off his student loan early? Or would he be better off using his money elsewhere? What does Ben think? For the starting salary of £60,000 per year, James is going to be a pretty high earner.

Ben Waltmann
Yeah. So I should say that I’m not a financial adviser, so I wouldn’t want to give anyone financial advice here; that everyone’s circumstances are different.

Claer Barrett
Understood.

Ben Waltmann
That being said, so our kind of very rough guess is that if you’re earning £50,000 by the time you’re 30, then it’s gonna be roughly a 50-50 chance whether you’re going to pay back that loan or not. Below that level, I wouldn’t be thinking about it at all because chances are that any repayments that you make are essentially a gift to the taxpayer, as it were.

Claer Barrett
Yes.

Ben Waltmann
And you’re never, you’re never going to benefit from that at all. And for people earning more than that, when we get to James’s sort of salary, I’m guessing that by age 30, he’s probably going to be earning more than £60,000.

Claer Barrett
Mmm.

Ben Waltmann
Then it becomes more likely that you will actually repay it. And that could mean that it is advantageous to repay early, depending on personal circumstances.

Claer Barrett
Now, let’s come on to some of the cons, because of course, there’s no guarantee that his salary level is going to continue to be high for those 30 years. That’s the kind of thing that I would caution. But then how about you?

Ben Waltmann
Yeah, I really agree with that. I think it’s very unpredictable, salaries over that long period, 30 years, as you say. He might want to change career. It’s also possible that he will have caring responsibilities. There’s all kinds of personal reasons why he might not have the same salary going forward. That’s one thing. But also another point that I’d really emphasise is the policy uncertainty, the uncertainty coming from the political side, because all of this is assuming the system stays in place for the next 30 years. But actually what we’ve seen over the last 10 years is that is constantly changing. The parameters of the system are fundamentally reformed every two, three years. And so he could find himself in a situation where he’s made a payment towards his student debt and then the government decides to cancel all the student debt. So then again, he would have made a donation to the taxpayer, which he needs to know whether he’d be happy with that.

Claer Barrett
And you mentioned caring responsibilities there. The IFS research that you’ve done on people who have graduated has found that women who, let’s face it, are more likely to have the caring responsibilities for young children, it makes far less sense for them to try and pay off their student loans, even if they are really high earners because of that upset to the income balance.

Ben Waltmann
Yeah, that’s definitely true. What we found is that because women are much more likely to take time off the labour market and because they are likely to not have the same sort of career trajectory as men in their thirties, so women are less likely to pay off their loans and so it makes less sense to make these repayments for them.

Claer Barrett
Plus, do keep in mind, if you do decide to pay back your student loan early, you can never get that money back if your circumstances change.

Ben Waltmann
So suppose you pay in a large sum when you don’t think you need the money, and then the day comes when you do need the money, maybe because you are out of work or you want to start a business, or on your downpayment on the house, then you cannot take it back (inaudible) if you’d invested it and it would still be there for you to withdraw.

Claer Barrett
So that’s what higher earners like James need to weigh up. But what about low or middle earners? People earning under the repayment threshold of £27,295 won’t end up paying back anything over the 30-year period. If you earn just over that threshold, you won’t pay back very much either. But here’s what you need to think about. For middle earners, the student loan could end up costing them more in the long run than higher earners.

Ben Waltmann
Yeah. In terms of your student loan repayments, for sure you’ll be repaying more if you’re earning 50,000. And in fact, you might be repaying more than if you were earning 80,000.

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Claer Barrett
Why? Because if you’re earning £80,000 a year, you’ll be making bigger repayments each month and therefore pay off the loan faster so there’s less time for the interest charges to build up. However, if you’re on £50,000 a year, you may be making repayments for the full 30 years. And as the interest builds up, the total amount you pay off over the years could be higher. Looking ahead, there are changes on the horizon for people starting university from next September. Here are three you need to know about. Number one . . . 

Ben Waltmann
The repayment thresholds will be even lower. It will start at £25,000. And then it will also be frozen for even longer than for the previous cohorts.

Claer Barrett
And the second change, prospective students need to be aware of . . .

Ben Waltmann
The repayment period. So how long you have to repay your loan will be extended from 30 years to 40 years. So many will be repaying their loans until their sixties, potentially.

Claer Barrett
And thirdly . . . 

Ben Waltmann
So this will be more welcome news to graduates. The interest rate will be cut substantially. So basically, everyone will be paying interest at the rate of RPI inflation, which is much lower than the current rates, whereas were up to RPI plus 3 per cent for high earners.

Claer Barrett
The question then is who wins and who loses from these changes?

Ben Waltmann
Some of the high earners who will be paying off their loans really benefit from the interest rate cut, whereas for the kind of low and middling earners, the lower repayment threshold and the longer repayment periods actually mean that they might be repaying more.

Claer Barrett
And people listening to this podcast, I mean, the prospects of repaying a 9 per cent slice of your earnings above £25,000 until you’re potentially in your sixties, I mean, it’s pretty hard to get your head around. I think if I were 18 or 19 now, that would really put me off going to university. What do you think?

Ben Waltmann
I mean, I’d say it really shouldn’t be putting you off going to university because university, as far as we can tell, is still a very good deal financially for most students. It does depend on which subject you studied. But in total for a typical student, the earnings boost would far outweigh the extra payments and student loans.

Claer Barrett
So that’s a research economist’s view on student loans. Next, I wanted to find out what a financial adviser makes of James’s question. If he can afford to, could it be worth paying off a student loan early, or would you be better off investing that money elsewhere?

Jason Butler
My name’s Jason Butler. I’m a former financial adviser. I focus on teaching people how to improve their financial wellbeing, mainly through the workplace.

Claer Barrett
And friend of the podcast, I should say. Well, you heard some clips from James there. I mean, what do you think about his situation and his feelings about student loans?

Jason Butler
I think he’s getting a bit confused in his thinking about what the problem is. I think he’s looking for a solution to a problem that doesn’t actually exist. The most important thing that you will have in your life to create wealth is your ability to earn money. So he’s already ticked a massive box. He’s starting with £60,000 a year, which clearly he thought was just average. But actually, we know it’s twice the median earnings. OK? So it’s about £30,000 in the UK. He’s on 60. He’s already twice ahead of everyone else. OK? So the second thing I think he needs to think about is he’s not, he’s got to try and anticipate not just getting a return on his investments, but getting a return on his life. And what that means is when you’re young, it means, OK, I’m investing my career. I’m investing in growing myself and my character and my ability, my connections and the people I know. It’s also having some fun and some enjoyment because in your twenties, I don’t know about you, Claer, but I certainly invested a lot in having fun and it was a money well spent, I think, in many cases.

Claer Barrett
I’m glad you frame it as an investment.

Jason Butler
Yes, absolutely. So here’s the point. I’m not convinced that the student loan, getting that away from him is an issue. It’s, as far as I’m concerned, it’s a tax which you only pay if you earn money. So the thing about this individual, this guy is that he’s very young. He’s got, he’s also off to a great start. He doesn’t quite know what the future holds. And maybe he starts a business. He might, but he wants to buy a house or an investment property. So I just don’t think he should be focusing on the pain of the student loan. It’s a contingent tax that you will pay if you earn and you won’t pay if you don’t.

Claer Barrett
So clearly James has got a little bit of money and he’s hoping to save money as he earns. And he has some questions about what kind of options he could have with that.

Jason Butler
I think with him, until he’s got his career established, until he’s clear about his shorter-term objectives, I would be encouraging him to stack his cash. Now, I’m not saying don’t invest, but if he was going to invest, I’d be suggesting that if he’s got, say, let’s just say he has £1,000 a month spare, if he starts off putting, say, £200 a month into, say, a global index fund, whether through an Isa or whatever, make sure that he’s doing the maximum he can into his workplace pension if he has one, and to get free money from his employer and the government and tax relief all the time that’s available. And then the rest of it I would just be building up into a savings account. You can get 3 per cent, 3 and a bit per cent instant access. Now, it’s not the same as inflation, but interest rates are going up and the outlook for inflation is going to be falling.

Claer Barrett
Mmm. Now Jason, for other people listening, if they’re thinking I should prioritise my goals and look at the financial milestones, how do you think they can go about that, especially considering the pressures on young people’s budgets today?

Jason Butler
Just really get good at creating a spending plan. We don’t do budgets. We do spending plans. If you can get good at that, that is the habit of being conscious about money. That’s how you control. You can try and start to make sure that there’s more money coming in than going out. Then you can start deciding where do you want your money to go beyond just living costs. But beyond that, I would say to yourself is that life will always throw you curveballs and it will not go in a straight line. And you have to get used to learning to cope with adversity, disappointments, obstacles and problems. With your money, like everything in life, you are looking to make small, sustainable progress, not achieving some ideal perfection that exists only in someone else’s dreams, Instagram accounts or imagination.

Claer Barrett
Exactly.

Jason Butler
Here’s the thing: even if you’re not earning what you think you deserve or need to live, all the studies show is having a job and being working with other people and having some sense of purpose and fulfilment is the thing that makes us feel the richest in the world compared to people who are not in a job, even if it’s not perfect, but people who are not in a job are not as happy as people who are in a job. So, you know, that’s just the sort of thing to leave you with that.

Claer Barrett
I went back to James to see what he made of the experts advice.

Jason Butler
Yes. Yes. A lot of information there. I think it was very useful to know about the advice of the first adviser. He said if you’re earning over 50,000 by age 30, then the 50-50 chance the loan will be paid off, I think that’s a very useful fact to bear in mind when making a consideration. And then I think it was interesting to hear some of the different factors. Say, for instance, caring responsibilities is one factor that I hadn’t really given a great deal of thought to. And then also Jason Butler talking about investing in life as well . . . 

Claer Barrett
Yeah, it’s true as well.

James
. . . (Laughs) I think that’s something that I hadn’t I hadn’t really considered that much. And I think quite often when thinking about financial decisions, I tend to maybe not consider emotions that much, but in fact, it is good to consider life quality. The fact that I am in my twenties and I probably am likely to maybe want to do some different interesting activities. So I think it’s definitely good to consider that for sure.

Claer Barrett
Absolutely. It is nice to just have a bit of reassurance, isn’t it? Whatever you think about money, if other people think it’s you, then it’s all about feeling comfortable that you’ve understood the decision that you might be making or not making and the reasons why that might be good or might be bad.

Jason Butler
Yes, for sure. Yes, it’s great. It’s great to know what the factors are and also to know that the the different factors that maybe I would have worked out by myself, but not been absolutely sure about. But thanks very much. And thanks very much for having me on the show.

Claer Barrett
Thank you, James, so much for coming on Money Clinic and sharing your thoughts about student loans with all of our listeners.

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That’s it for Money Clinic this week, and we hope you like what you’ve heard. If you did, spread the word and leave us a review. And if you’d like to chat with me on a future episode of the show, you can email me. Our address is money@ft.com. Or DM me on Twitter, Instagram or TikTok. I’m @ClaerB. Money Clinic was produced by Persis Love and Philippa Goodrich. Our executive producer is Manuela Saragosa. Our sound engineer is Breen Turner. And the original music is by Metaphor Music. And finally, the Money Clinic podcast is a general discussion around financial topics and does not constitute an investment recommendation or individual financial advice. For that, you’ll need to find an independent financial adviser. That’s the small print over and done with. See you back here soon. Goodbye.

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