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Consumer Advice: Money-Saving Expert Martin Lewis advises whether you should pay off your student loan
By: Martin Lewis
Money saving Expert Martin Lewis
Money saving Expert Martin Lewis
Money-Saving Expert Martin Lewis on paying off student loans
16 September 2010
The halcyon days of interest-free student loans have just ended.
And this isn’t all about fresh faced twenty year olds – if you’re one of the 3.7 million graduates who haven’t cleared their debt yet, even from twenty years ago, beware.
Last month, the official student loan company interest rate was, at worst, interest-free, and some were even shrinking.
Last month, the official student loan company interest rate was, at worst, interest-free, and some were even shrinking.
Yet, from 1 September, the tables turned: what you actually pay depends on when you started your studies.
· Pre-1998 student loans
Now 4.4%, was -0.4%
If you are one of 350,000 graduates who now have these over ten-year-old loans outstanding, then your rate has gone up a huge amount. You’re now being charged a large 4.4% interest.
That’s because September’s new rate depends strictly on the rate of inflation (RPI) in the previous March. In the prior year that was negative, so for a year you had loans shrinking by 0.4%. Now you’ll pay this year’s positive 4.4%, ie, £440 per year per £10,000.
Now 4.4%, was -0.4%
If you are one of 350,000 graduates who now have these over ten-year-old loans outstanding, then your rate has gone up a huge amount. You’re now being charged a large 4.4% interest.
That’s because September’s new rate depends strictly on the rate of inflation (RPI) in the previous March. In the prior year that was negative, so for a year you had loans shrinking by 0.4%. Now you’ll pay this year’s positive 4.4%, ie, £440 per year per £10,000.
· Post 1998 and new student loans
Now 1.5% and could rise more, was 0%
For the last year, the loan has been interest-free, but is now 1.5% and could rise more even before September.
This is because the rate you pay is rather complicatedly set at the lower of:
Inflation at the prior March (4.4%) or a measure similar to UK base rates (0.5%), plus 1 percentage point.
So, if you are one of the 3.3 million graduates with one of these loans outstanding, while it’s currently 1.5% or £150 per year per £10,000 of debt, if UK interest rates rise, so will the amount of interest you are paying, up to a maximum 4.4%.
Now 1.5% and could rise more, was 0%
For the last year, the loan has been interest-free, but is now 1.5% and could rise more even before September.
This is because the rate you pay is rather complicatedly set at the lower of:
Inflation at the prior March (4.4%) or a measure similar to UK base rates (0.5%), plus 1 percentage point.
So, if you are one of the 3.3 million graduates with one of these loans outstanding, while it’s currently 1.5% or £150 per year per £10,000 of debt, if UK interest rates rise, so will the amount of interest you are paying, up to a maximum 4.4%.
Should I pay off my student loan?
Now millions are paying interest, it’s hardly surprising that I have been bombarded with emails from people with spare cash asking if they should use it to pay off all, or part, of their student loan.
So you may be surprised to read that, for most people, the answer is a firm No.
To explain why, it’s important to understand why technically there is no “real” cost to student loans, as the interest rate is only ever as high as the rate of inflation.
Think of it like this: if you borrowed enough money to buy a hundred shopping trolleys worth of goods, you will only ever have to repay roughly the cost of the same trolleys of goods because the cost of your loan rises in line with prices.
So while the actual amount of cash you have to repay is higher, student loan borrowing doesn’t diminish your purchasing power in any way.
This means that while the interest rates may have jumped, they are still the cheapest long term debt that you will ever be able to get.
Consequently, it’s worth carefully considering whether you should use spare cash to pay them off.
The correct answer depends on your exact circumstances:
Now millions are paying interest, it’s hardly surprising that I have been bombarded with emails from people with spare cash asking if they should use it to pay off all, or part, of their student loan.
So you may be surprised to read that, for most people, the answer is a firm No.
To explain why, it’s important to understand why technically there is no “real” cost to student loans, as the interest rate is only ever as high as the rate of inflation.
Think of it like this: if you borrowed enough money to buy a hundred shopping trolleys worth of goods, you will only ever have to repay roughly the cost of the same trolleys of goods because the cost of your loan rises in line with prices.
So while the actual amount of cash you have to repay is higher, student loan borrowing doesn’t diminish your purchasing power in any way.
This means that while the interest rates may have jumped, they are still the cheapest long term debt that you will ever be able to get.
Consequently, it’s worth carefully considering whether you should use spare cash to pay them off.
The correct answer depends on your exact circumstances:
· Do you have other debts?
Clear your most expensive debts first. As student loans are such cheap-long term debt, you’d be far better off clearing all others before it.
While this is obvious with credit cards at 18% interest, it’s trickier with super-cheap mortgages. Yet, remember, in the long run it’s likely the mortgage will be more expensive. Depending on what penalties are payable, it’s probably worth repaying some of your mortgage rather than the student loan.
The main exception to clearing other debts before student loans are 0% credit cards, but, even here, when the 0% rate ends, the APR rate will soar. So unless you are extremely savvy and using a technique called “stoozing” (if you don’t know what it is you are not doing it – see www.moneysavingexpert.com/stoozing), then you are probably best repaying credit card debts first.
Clear your most expensive debts first. As student loans are such cheap-long term debt, you’d be far better off clearing all others before it.
While this is obvious with credit cards at 18% interest, it’s trickier with super-cheap mortgages. Yet, remember, in the long run it’s likely the mortgage will be more expensive. Depending on what penalties are payable, it’s probably worth repaying some of your mortgage rather than the student loan.
The main exception to clearing other debts before student loans are 0% credit cards, but, even here, when the 0% rate ends, the APR rate will soar. So unless you are extremely savvy and using a technique called “stoozing” (if you don’t know what it is you are not doing it – see www.moneysavingexpert.com/stoozing), then you are probably best repaying credit card debts first.
· Are you debt-free?
You may think if you’re debt-free clearing the student loans a no-brainer. Yet first consider whether you’re planning to borrow elsewhere in the future. For example, you may be a recent graduate looking to buy a house or need a loan to get a car.
If so, it doesn’t make sense to pay off your student loan now only to reborrow money again using commercial debt like a mortgage or personal loan at much higher interest rate. You’d be far better off putting your money aside in a top savings account. Then, when the time comes, use those savings to reduce the amount you need to borrow using a more expensive form of debt.
It’s also worth remembering that student loan debt (with the technical exception of you defaulting on a pre-1998 loan) doesn’t get listed on your credit file so won’t affect your credit rating.
You may think if you’re debt-free clearing the student loans a no-brainer. Yet first consider whether you’re planning to borrow elsewhere in the future. For example, you may be a recent graduate looking to buy a house or need a loan to get a car.
If so, it doesn’t make sense to pay off your student loan now only to reborrow money again using commercial debt like a mortgage or personal loan at much higher interest rate. You’d be far better off putting your money aside in a top savings account. Then, when the time comes, use those savings to reduce the amount you need to borrow using a more expensive form of debt.
It’s also worth remembering that student loan debt (with the technical exception of you defaulting on a pre-1998 loan) doesn’t get listed on your credit file so won’t affect your credit rating.
Debt-free and know you’ll never need to borrow again?
Now you really may be convinced there’s no reason not to pay off your student loan. Well, if you’re one of those on the old 4.4% interest loans, you’re quite right. The cost of the loan is far more than you could earn in savings.
However, that rule doesn’t apply to people on the newer loans, currently only paying 1.5 percent.
If you were to stick the money into a high-interest cash Isa (see www.moneysavingexpert.com/cashISAs), where you could easily get 2.8 percent tax-free, you would be earning more interest than the debt costs. In effect, you would be making money out of not repaying the loan.
The only time you shouldn’t do this is if you have no self-discipline and, rather than save the cash, would go out on a spending spree and get rid of it.
In that case, even though the clinical financial logic isn’t right, the best thing to do is to pay off the debt.
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Now you really may be convinced there’s no reason not to pay off your student loan. Well, if you’re one of those on the old 4.4% interest loans, you’re quite right. The cost of the loan is far more than you could earn in savings.
However, that rule doesn’t apply to people on the newer loans, currently only paying 1.5 percent.
If you were to stick the money into a high-interest cash Isa (see www.moneysavingexpert.com/cashISAs), where you could easily get 2.8 percent tax-free, you would be earning more interest than the debt costs. In effect, you would be making money out of not repaying the loan.
The only time you shouldn’t do this is if you have no self-discipline and, rather than save the cash, would go out on a spending spree and get rid of it.
In that case, even though the clinical financial logic isn’t right, the best thing to do is to pay off the debt.
New 3% savings that RISE with base rate
If you lock up cash for a year, thisnew savings deal is possibly the best of both worlds: like fixed savings, you get higher interest for locking cash away, but it's also guaranteed to rise with interest rates.The Santander Tracker Bond (min. £10k) guarantees to be 2.5% above base rate until it ends in Oct 2011, so it's currently 3%; some existing Santander customers get 0.25% more. No withdrawals are allowed. FULL info and daily updated best buys at www.moneysavingexpert.com/savings
Travelodge £9 winter room sale
Travelodge has released 25,000 £9 rooms, available for November 2010 to January 2011 stays. The usual cost is £29-£59 – book early for availability. For full details, go to www.moneysavingexpert.com/travelodge
Travelodge has released 25,000 £9 rooms, available for November 2010 to January 2011 stays. The usual cost is £29-£59 – book early for availability. For full details, go to www.moneysavingexpert.com/travelodge
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TV money guru Martin Lewis runs the consumer revenge website MoneySavingExpert.com; ensure you get his weekly e-mail so you’re constantly saving money.
