Hello fellow Protagonists,
Those who have read my recent post will know that I have now paid off my car loan.
So what is next?
General guidance in personal finance would suggest that I move on to my next debt until I become debt free. Here is the catch, my last remaining debt that is not the mortgage is my student loan. Paying off debt is a key component to becoming financially independent. Also, regardless of where our debt is coming from, we are still servants to our lenders until this is paid off (or written off).
From my experience much of the personal finance guidance on the internet is from our cousins across the pond. We can learn from each other as many financial concepts are similar; this I feel is not one of those topics.
A key difference between much of the the American based guidance, and the position here in the UK, is that we all eventually have our student debt wiped clean, depending on when we started university. When you also throw in to the mix that we are currently experiencing low interest rates, and thresholds to reach before you even start paying off the debt, this can be a confusing decision for many of us.
This could mean that we end up chucking money at our student debt needlessly if we do not play it right. I want to go through with you the 6 points I considered myself before making my decision on whether to pay off my student loan early or not. Hopefully this will help you to make your own decision.
Before I start it is important to add that there are far too many clauses involved when discussing something like this to cover the information every person requires. I will add a link at the end of the post to help obtain answers to any of these specific points.
Point 1 - How much student debt do you have?
This can vary a lot from person to person, depending on what tuition fees were at the time, whether you lived at home or in student accommodation and so on. We need to know this number before we can start our quest. I am delighted to inform you that my student debt is around £20,000.
Point 2 - What plan are you on?
For English, Welsh and EU students there are two main plans, ingeniously called Plan 1 and Plan 2. The border between being a 1 or a 2 is whether your first year of uni started before (Plan 1) or after (Plan 2) the 1st September 2012.
I am on Plan 1 so used this for the basis of my decision. A simple change of some thresholds and percentages will put you back on track if you are on Plan 2. Currently on Plan 1 servants will only repay if their income is over £1,615 a month, before tax. Plan 2 is £2,214 a month and if you were braver than me and took a Master's or Doctoral Loan, this is £1750 a month.
Point 3 - How long left do you have before the loan is written off
Plan 1 is 25 years after the first April you started paying back. Plan 2 is 30 years. The number of years remaining to pay will have a big influence on our decision to pay off the remaining balance or not. Less time before being written off would usually mean less benefit, whilst longer periods open us up to longer accumulation of interest. I will go on about interest later.
For me this is just shy of 16 years.
Point 4 - If we were to continue to pay off the same amount as we are now, how much would that come to?
Hopefully we all go on to earn more money in the future but this is a difficult thing to predict. This is why I focus on what I am paying now as a general rule of thumb for my decision.
If you are PAYE (get a pay slip) it is really easy to see what is taken out each month as it should be written on it. For self-employed people you get informed how much to pay from your annual self assessment.
As for the amount taken from your pay, this would be 9% of the amount you earn over the threshold for Plan 1 and 2, reduced to 6% for post grad study. You also don’t get tax breaks on student loans. The amount is worked out by your pre-tax income, but is paid out post-tax. Cheeky eh?
For the purpose of this post I will use simple round numbers (£1200 a year). When applying your own numbers the more precise the better informed you will be.
£1200 a year for 16 years would be £19,200 which is just short of my £20,000 remaining balance.
Some people may be able to make their decision at this point if the balance is far in excess of what you would be able to pay off. This is not necessarily a bad thing as when it is cleared you have potentially prevented tens of thousands of pounds of repayment than any other type of debt would still be chasing you for.
Point 5 - If paying off our student loan still interests us, how quickly could we pay this off.
You can base this from your savings rate. Taking the £20,000 figure as an example; if we were able to squirrel away £500 a month on top of the regular payments we may be able to pay this off in around three years. If £100 sounds more realistic then this could look more like 9 years.
The longer the time this will take to pay off, the harder the last jigsaw pieces is to fit. which is,
Point 6 - The interest that is accrued on your student loan
The interest on your student loan could change greatly over the course of its lifetime. This is very difficult to predict. Plan 1 is set at 1% over the English base rate, which would currently equate to 1.1% (seriously low). Applying this rule over the last 20 years, we would see that the highest rate could have been 7% in Feb 2000, though student loan repayment rules were different back then.
Plan 2 interest rate range between +0-3% depending on how much you earn.
To put things into perspective the difference this could make if my £20,000 remained at 1.1% for the 16 years then the final balance would be £23,468.65 (if nothing was paid off during that time). The Interest Rate in the United Kingdom averaged 7.40 percent from 1971 until 2020, this number would leave me watching an 8.4% yearly increase on my £20,000 and a final balance of £76,328.78. This is a game changer for those who are thinking of paying their student loan in a prolonged time frame. We have faced low interest rates for some time now. We would be naive to think this will always be the case.
If you are going to pay it off, go for the jugular and pay it off as fast as you can.
Luckily we have compound interest calculators to help us out. I have used this free one for as long as I can remember.
On the calculator just pretend you are the bank rather than a servant. I can enter my £20,000 into the base amount, add the interest rates and a deposit from the base amount for the amount you would look at paying off each month. Remember that student loan interest rates are calculated monthly. Hit go and see the table. The year the balance turns to 0 is how long it would take you to pay.
Your decision may also come down to what your risk tolerance to money is like. Paying off debt will give you an increase in future disposable income, and paying off a 4% debt is the equivalent of investing and getting a 4% return. Investing that money differently could provide you a higher rate of return but is not definite. In theory paying off a 1.1% interest debt would not make the world of difference. On the other side of the coin, paying off loans when they are variable and at a current low point means that the money you would pay off them would take out larger portions of the capital.
So what decision am I making?
After contemplating all this information I have made the decision that I am not going to be paying off my student loan early at this point in time. I would not be surprised if the vast majority of UK graduates around my age also come to this conclusion.
For me this may alter if situations change, such as a steep increase in income, increased interest rates or just a general shift in priorities.
If I was to decide to pay off my student loan early right now I would personally keep it in a separate account rather than overpaying the student loan company each month. I understand that this would increase the overall amount I would need to pay, but with a 1.1% interest rate it would not make the world of difference. It also means that if interest rates increase drastically over a short period of time and I could no longer pay of the debt comfortably, I would not have thrown my money down the drain.
What are your plans with your student debt? Let me know if you are going for it and paying yours off.
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