Student loan interest rates have jumped to a staggering 6.1% this year, leading to students from England graduating with an average debt of £50,000. Should this make you worried? Let’s crunch the numbers and see.
Why so much, you ask?
The simple answer: Brexit. Since the referendum results in June 2016, sterling has fallen by a substantial 17%. The weakening pound has driven inflation to reach a 4 year high, with the Retail Price Index (RPI) now standing at 3.1%. This results in the increase you see in student loan interest. Brexit has caused a rippling effect throughout the economy and graduates will now start to feel the effect.
Should we be worried?
At first, this may seem like very bad news for graduates but there is more to it than meets the eye. There are four main policies that should shape the way we think about student loans:
You don’t have to begin paying off your loan until you earn over £21,000;
You only have to pay 9% of your earnings over £21,000;
After 30 years, your remaining loan balance is written off; and
Student debt does not affect your credit score.
What does that mean for us?
Let’s assume the average UK graduate will start on a salary of £25,000 with a salary growth of 2.5%. Following this progression, we expect that 30 years into the graduate’s professional career, they would be earning around £50,000.
So, given the second policy, that graduate would only have to pay around £360 in their first professional year. Their annual payment would increase to around £920 in year 10 and would continue to climb throughout their career to reach £2,700 in year 30. By contributing the mandatory 9% each year, even with the increase, a graduate would be looking at a total payment of £42,000 before their debt was written off completely.
The graph below compares the debt that the average UK graduate will accrue over 30 years, to the amount they will have to pay back. As you can see the debt increases faster than the payments, with the difference between these two lines representing the remaining balance the student still owes.
So, what should we do?
If you think these statistics are worrying, then you’re not alone. But how much can we really do about it? Well, the answer is the third student loan policy. So, do we just let debt accrue for the majority of our professional life? To the average person, the answer to that question is yes. The data shows that even if the average person earned a stable salary over those 30 years, they would still have accrued around £200,000 in debt.
Paying back more than the minimums won’t help you either. To put that into context; if you decided every year to pay 5 times as much as you have too, you will only pay your loan off in year 21. If you decided to pay 10 times as much, then you would still be paying your loan off until year 12. There is also the option of paying your whole loan off straight away, but who has £50,000 just lying around?
If you are the type of person who feels that their loan is holding them down, then feel free to pay more off. However, you must ask yourself if the added payments will result in your loan being paid off completely before year 30. If they don’t, then that money will have had no effect. In year 30 your debt will be written off, be that a £2,000 debt or a £200,000 debt. A crucial point to be made is lying in that final clause: student debt does not affect your credit score. So, while you may choose to pay it off early, you will not be penalised if you can only contribute the minimum mandatory payments each year.
If the psychological effect of debt is too much for you and if you happen to be in the fortunate situation where you can afford to pay the loan off instantly, should you? We can’t speak for every person’s situation but if you are able to and wish to rid yourself of debt early then paying it off as soon as possible is your best bet. That way you can be debt free without racking up additional debt with the yearly interest.
Whether your concern is becoming debt free as soon as possible or minimising long-term costs, the higher interest rates (as scary as they sound at first) will have a much smaller impact than many believe. Regardless of your situation and financial goals, Bean will continue to provide helpful information and resources for achieving them.
Please note that this article is based on the four student loan policies that are currently in place, with principle three and four being the main driving factors of these conclusions. Policies are subject to change and this must be noted before any student loan decisions are made.
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