Should I repay my student loan early?

I did my undergraduate degree at the University of Glasgow from 2007 until 2012. As a Scottish resident, and with parents earning under a certain threshold, I was entitled to a student loan from the Student Awards Agency Scotland (SAAS) managed by the Student Loans Company (SLC). Put simply, SAAS worked out how much I was entitled to and SLC gave me the money.

The subject of student loan repayments is full of jargon so I thought I’d write a blog post about it to clear it up in my own mind, and maybe help others in similar situations to me.

My loan

Over the course of my degree I received around £340 a month throughout academic years 07/08, 08/09, 09/10, 10/11 and 11/12. As the academic year at Glasgow lasted from September until May, I was not paid over summer, but I did pay interest on the debt. I was paid slightly more at the start to cover textbook purchases.

As I started my degree in 2007, and as I was a Scottish resident, my loan was a so-called “post-1998, pre-2012 plan 1” loan. The structure is as follows:

  • Interest is applied to the loan yearly, representing the period between 1st April and 31st March.
  • The interest rate is based on the lower of two metrics. The Retail Price Index (RPI) announced by the Office for National Statistics every month is one, and the March rate is the relevant one for the calculation of interest in a given year. The other is the Bank of England base rate, plus 1%. The lower of the two figures is used to calculate the interest.
  • Repayments start once you earn over £17,335 in a given tax year. You pay 9% of the amount earned above this threshold, with no upper limit. Her Majesty’s Revenue and Customs (HMRC) automatically subtract the student loan repayment from your salary before it is paid to you.

Incidentally, anyone in England and Wales who started their education on or after 1st September 2012 gets a much worse deal thanks to the ConDem government. They pay RPI + 3%, a so-called “2012+ plan 2” loan. Poor sods.

Over the course of my education I accrued around £18k of student loan debt. As I started a PhD immediately afterwards, I didn’t earn a taxable income for another 4 years after graduation. Today, as I write this, I have just finished and I have accrued an additional £1k or so on top of the £18k I had at the end of the degree.

Repayments

As I now have a job earning over the minimum threshold, I have started to repay my student loan. The question crossed my mind recently as to whether it is worth trying to pay more than the minimum, automatic deduction taken by HMRC, in order to pay off the loan earlier.

Before thinking that it is always a good idea to pay off loans, recall the clause above: the interest rate is the lower of either the RPI, or the Bank of England base rate + 1%. The RPI tracks the cost of a basket of “typical” goods (a list can be found as one of the links on this page – new for the 2016 basket are microwave rice, coffee pods and computer game downloads), and as such it should represent inflation. The Bank of England base rate is the rate at which the government lends money to retail banks for short periods should they need it to maintain liquidity. This is passed on to consumers by retail banks in the form of savings account interest rates, and so a higher Bank of England base rate should in principle be reflected in higher savings interest rates. As the student loan interest rate is determined by the lower of these two, it is almost always substantially lower than rates of commercial loans. If the cost of goods goes up, your salary should in principle go up too and so your loan interest rate goes up.

So in real terms, the loan costs, essentially, nothing. The £340/month payments in 2007 are the equivalent of £425/month in 2015 due to inflation. The £19k debt I now have is equivalent to having had 50 monthly payments of £380, and so at 2007 prices my loan’s interest has been slightly lower than inflation since 2007. With the SLC having charged less than average inflation on my loan, I’ve essentially earned free money in real terms to “pay off” the debt that would otherwise have accrued at an inflation based interest rate.

But, what if you have money to burn after you get your salary having paid tax and the minimum student loan deduction? Consider the opportunity cost of the money you would use to pay off the student loan. This is the money you would lose by not using the money to pay off debt, but rather to earn interest in a savings account or to invest. To calculate the opportunity cost you must take the difference between the money you save in debt interest (having reduced the total amount owed by paying a little off) and the money you would earn by investing the same payment in some way. As the interest on the student loan is usually at inflation or lower, any reasonable bank account should pay more in interest. You can even earn significantly more effective interest by investing the money over very long periods in index funds, but that’s another topic for another time.

Furthermore, if you happen not to pay off your loan within 35 years of the first payment, the government writes it off. For me I hope this won’t matter, as I hope to earn what I consider to be a decent salary at least as much as I do now until I retire, and will have paid off the loan within a decade or so. But it’s a nice perk that if, for whatever reason, you drop below the repayment threshold you won’t be getting a visit from some burly debt collectors.

By this logic, it is better to make the minimum payment on the student loan and put whatever extra you would have paid towards it in some savings or investments.

So that’s what I’ll do. The story changes if you have a different scenario, such as a horrible plan 2 loan for English and Welsh students starting after 2012. If you have one of those, I advise you to do your own calculations as to whether to pay it off or not, and not vote for another government like that in the future. It’s also another story, for that matter, if you’re not a UK resident. US residents have different rules entirely, and in some cases this debt doesn’t die with you and is immune from being written off during a bankruptcy. Goodness me.