Why you shouldn’t be in a hurry to pay off student debt

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The Brexit vote may be causing interest rates on loans to fall through the floor, but, sadly, for students and graduates there is one exception. Rates on newer student loans will soar by up to 75 per cent this month because of an ill-timed rise in inflation this year. This, combined with the withdrawal of maintenance grants and a political U-turn on repayment terms, has created the toughest financial conditions for students yet. No wonder that Generation Regret, a report by the insurance company Aviva, found that a third of recent graduates wish they had not studied for a degree, while half believe they could have got their present job without it.

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The good news is that only a few graduates will be forced to pay the full whack; many will get away with paying nothing. As students (and parents) wonder how much a degree really costs, we look at why the loan rates have changed and who is affected.

Why has the rate gone up?
Under the student loan regime introduced in 2012, interest rates are pegged to the retail price index (RPI), measured once a year in March. The new rate kicks in the September after.

For those still studying, the interest on the outstanding balance builds up at the considerable rate of RPI plus 3 percentage points, but they do not have to make any repayments during this time.

When they reach the first April after graduation, the loan starts accruing RPI inflation for graduates earning less than £21,000, but they start paying back the loan (plus interest) only when they earn more than £21,000. At this point they pay back 9 per cent of earnings above the threshold plus a sliding scale of interest.

The RPI rate of inflation rose to 1.6 per cent in March, so this is the basic interest rate paid by graduates earning £21,000, rising to a maximum of RPI plus 3 percentage points (so 4.6 per cent at present) for those earning at least £41,000 — a total of 4.6 per cent.

How does this compare with last year?
Graduates had a reprieve last year when the March RPI figure came in at 0.9 per cent. As a rough guide, someone with £40,000 in student debt (common for graduates in expensive cities) can expect to pay an extra £280 in interest this year, rising to £310 if they owe £45,000.

How long does this apply?
The rate will remain until the RPI is measured again in March, with the new rate coming into effect in September 2017.

Tom Stevenson, the investment director at Fidelity International, says: “With inflation expected to rise as a result of Brexit, students should be prepared for a spike in their student loan interest rates.” Inflation was as high as 5.6 per cent five years ago; in reality, most economic projections put the figure between 1.7 and 2 per cent for next year, but these can be unreliable.

Who does the rate rise apply to?
In theory, anyone who started their university course after September 2012. However, only those earning more than £21,000 after graduation will be affected.

Any increase in RPI will inflate the amount of debt students may have to pay in the long term, but this will be felt by graduates only when they are required to start paying back the loan. Students attending universities in England and Wales have also been hit with higher tuition fees, rising to £9,000. From next year universities and colleges that meet certain educational standards will be allowed to increase their fees in line with inflation, meaning they can charge up to £9,250.

Students attending Scottish universities are exempt from tuition fees, but usually attend university for four rather than three years and have to contend with a paucity of bursaries and high living costs; Edinburgh is the most expensive city in the UK for students, according to the Royal Bank of Scotland.

What other changes have been made?
Maintenance grants that help poorer students to meet the costs of university education will be replaced this year with maintenance loans.

Students will only be eligible for grants if they claim certain benefits, are disabled or need help with childcare costs. In 2015 George Osborne, the chancellor at the time, also increased the amount graduates will have to pay back in the long term by scrapping a commitment to raise the earnings threshold for loan repayments annually.

The threshold of £21,000 is now frozen until 2021. Martin Lewis, the financial campaigner, has raised the possibility of fighting the changes with a case in the courts, although he has recently said that the prospect of a legal challenge sadly, “doesn’t look good”.

Should I (or my parents) pay off my student loan?
Students can make extra payments towards their student debt, but this could be a bad move. They need to pay off the debt only once they start earning more than £21,000.

According to research from the Institute of Fiscal Studies, more than two thirds of graduates who leave university will never earn enough to repay the full amount and after 30 years any unpaid amount is written off.

Someone would be able to repay the debt in full within 30 years only if they had a starting salary of about £40,000, and their salary rose by 2 per cent above inflation each year, with no career breaks taken.

Mr Stevenson says graduates should think of their student debt more like a means-tested tax: “With student debt exceeding £50,000, even before interest starts to roll up, it’s likely that a significant proportion of students won’t repay their loan in full,” he says.

“If you think that you may work in a lower-paid job, or will take time off to raise a family, it may be that you will never pay the full upfront cost of your degree.”

You can use the student loan calculator at Moneysavingexpert.com to figure out whether it is worth you should clear the debt early (moneysavingexpert.com/students/student-finance-calculator).


BEST BANK ACCOUNTS

Times Money rounds up the best student accounts.
● Long-distance study
If you can make a deposit of £500 per term, go for the 123 Santander Student account. It comes with a free Young Person’s Railcard (worth about £100) for four years, giving you a third off rail travel, and it also pays 3 per cent on balances between £300 and £2,000. It offers a free £1,500 overdraft in years one to three and up to 2,000 for years four and five, but unauthorised charges are set at £5 a day, up to £50 a month. 
● Overdraft habit
The HSBC Student account offers up to £3,000 overdaft from your first year. The unauthorised overdraft comes with no fees, but the account is locked until your balance is returned to an agreed limit. You also get a £60 Amazon voucher and free Amazon Prime membership for a year and 1.75 per cent credit interest on amounts over £1,000. Nationwide FlexStudent has the same policy, but no freebies and only tiered interest going from £1,000 up to £3,000 over three years.
● The ethical choice
The Co-op Student account is the most ethical option on the high street. It offers no credit interest but the free overdraft limit is £1,400 in year one, £1,700 in year two and £2,000 in year three, with a £20 buffer.

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